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  Assessment and Recommendations

  Output in the euro area has recently been recovering from the 2000-01 slowdown. Growth had decelerated progressively from its peak in the first half of 2000, and turned negative in the fourth quarter of 2001. The slowdown was prompted by a series of shocks, most of them common to the OECD area. Aside from the 11 September events, these included the surge in oil prices in 1999-2000, the bursting of the ICT bubble and the ensuing slump in stock markets. The sharp downturn in foreign demand aggravated the situation. As a result, economic growth declined from 3½ per cent in 2000 to 1½ per cent in 2001, although the policy easing during the year cushioned the downturn to some extent.

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  Macroeconomic Developments and Prospects

  Output growth is just now recovering from the slowdown that took hold during 2000. Output growth in 2000 – at 3½ per cent – had been the strongest in nearly a decade, accompanied by robust job creation, while core inflation was still subdued. However, activity began to slow significantly from mid-2000 onwards and output fell in the fourth quarter of 2001. The slowing of growth largely reflected a number of common factors that operated to synchronise developments across the OECD, even though the impact and policy response have differed to some extent across countries and regions. First, the sharp hike in oil prices in 1999/2000 reduced purchasing power and squeezed profit margins, while the rise in underlying inflationary pressures led to a tightening of monetary policy by central banks, including the ECB. The continued weakness of the euro and strong monetary growth also added to concerns about the risks to price stability. Second, the ICT (information and communication technology) sector bubble burst, which initiated a sharp fall in share prices. Third, the simultaneous forces at work led to a slump in external trade. And finally, the 11 September events in 2001 seriously dented confidence. As a result euro area output growth fell to 1½ per cent in 2001. Employment has, nevertheless, remained fairly resilient and unemployment started to drift up only towards the end of 2001. With the unwinding of most of the negative shocks, a growth-supportive macroeconomic policy stance and a strong recovery in world trade, output growth is projected to gather steam during 2002 and to be above potential growth in 2003, while still leaving a negative output gap.

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  The Fiscal Policy Framework

  The fiscal consolidation that was achieved following the adoption of the Maastricht Treaty in 1992 has been very impressive, suggesting that incentives to this effect have been forceful (Figure 10). The euro area’s general government deficit fell unabated from its 1990s peak of almost 6 per cent of GDP in 1993 to 0.9 per cent in 2000 (excluding UMTS licence proceeds). While the recovery from the 1992-93 recession clearly played its part, the bulk of this improvement was structural, stemming from sustained cuts in primary cyclically-adjusted deficits. In addition, debt servicing cost fell, underpinned also by the convergence of interest rates in the run up to Economic and Monetary Union (EMU), towards the low levels prevailing in Germany, and the more favourable debt dynamics as economic growth firmed.

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  Monetary Management

  The Eurosystem’s record since the previous Survey of the euro area was released has been overall positive. The System readily weathered the financial stress in the immediate aftermath of the 11 September terrorist attacks, with coordinated action to inject liquidity into the financial system organised effectively and timely. As well, supported by extensive and careful preparation, the introduction of cash euros on 1 January 2002, and the subsequent withdrawal of legacy currencies, turned out to be very smooth. Monetary union is now a tangible everyday reality for over 300 million citizens in the euro area. Moreover, by fostering price transparency it is likely to boost competition to the benefit of all consumers. The changeover may have raised prices somewhat, but this impact is estimated to be small and is unlikely to last.

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  Policies to Boost Financial Market Integration

  The monetary union has been seen as boosting financial market integration by reducing costs, eliminating exchange rate risks and raising price transparency. The full potential of gains from monetary union will only be realised, however, if remaining barriers to integration are dismantled and competitive conditions in EU financial markets are ensured. Since the early 1970s the European Commission has pushed for the creation of a European financial area, and important progress has been made, as discussed in some detail below. Rather than establishing uniform regulation and supervision for a single financial market, the principles of home country control, harmonisation of essential principles and mutual recognition were applied, assuming that mutual recognition and market forces would interact to yield convergence in the regulatory environment. Accompanied by the global trend of financial market liberalisation, this sparked competition between financial centres, which had developed within their distinct national financial systems, changing the structure of financial markets over time. Competition between financial centres has intensified significantly with the introduction of the euro in 1999. Nonetheless, liberalisation has not yet gone far enough and deep integration of financial markets is still far from being a reality in several market segments.

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  The EU's Policy Processes

  The European Union’s unique governance structure has been shaped by the need to strike a balance between community-wide action and the subsidiarity principle. Its competencies, many of which are shared with the member states, are set out in the Treaties. On the one hand, the subsidiarity principle, which was introduced as a general principle in the Maastricht Treaty, guides the actions of the Community. The subsidiarity principle implies that Community-wide action should occur only if an objective can be better attained at the EU-wide level, and Community action should be commensurate with the objective pursued. In addition, the implementation of EU-wide policies is highly decentralised. On the other hand, the Maastricht Treaty spelled out clearly that co-ordination of economic policies is essential for the well functioning of monetary union and that economic policies should be regarded as a matter of common concern. The European Union has designed processes for co-ordinating economic and employment policies at the Amsterdam, Cardiff and Luxembourg European Councils. Eventually it is difficult to find economic policy issues that are not covered by these processes. All these processes are embedded in the overarching process of the Broad Economic Policy Guidelines.

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