2018 OECD Economic Surveys: Euro Area 2018

image of OECD Economic Surveys: Euro Area 2018

The euro area economy is growing robustly, and GDP growth is projected to remain strong in 2018 and 2019. These improved economic conditions should facilitate further reforms needed to enhance euro area resilience to downturns and ensure its long-term sustainability. Rapid resolution of remaining non-performing loans would facilitate new bank lending and better transmission of monetary policy. Governments should use the recovery to improve fiscal positions and gradually reduce high debt, which would reduce the risk of pro-cyclical fiscal stances in bad times. Simplifying the fiscal rules, while keeping the necessary flexibility, would make the rules more operational. Banking union remains unfinished and futher progress is key to achieve greater private risk sharing. To further loosen the potentially harmful links between banks and their sovereigns, a combination of policies incentivising banks to diversify their holdings of sovereign debt and the introduction of a European safe asset should be considered in parallel. A fiscal stabilisation capacity at the euro area level, such as an unemployment benefits re-insurance scheme, could help absorb large negative country-specific and euro area shocks and complement national fiscal policies. More integrated capital markets would deepen private risk sharing through more diversified financing and greater cross-border investment.



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Stabilisation policies to strengthen Euro Area resilience

The euro area sovereign debt crisis highlighted important weaknesses in the euro area design. Fiscal policy did not build sufficient buffers before the crisis, which forced some countries to tighten fiscal policy too rapidly during the downturn to restore market confidence in sovereign borrowing. Despite this, sovereign stress remained high, weakening further the banking sectors highly exposed to government bonds, which in return reduced further market confidence in fiscal sustainability in case of banks’ bailout. As a result, monetary policy was the main public instrument to support the activity, but its effectiveness was reduced by the fragmentation of financial markets along national lines as the crisis deepened. In order to durably sever the links between banks and their sovereigns, euro area countries agreed on a banking union. The creation of a common supervisor was a very important step in that direction. However, further progress is needed in reducing and sharing risks, creating a common deposit guarantee scheme and the application of existing rules to ensure sufficient risk sharing can take place in case of crisis. At the same time, incentives need to be put in place for banks to progressively move away from a too high exposure to domestic sovereign bonds. A step in that direction could be the introduction of euro area safe asset, which would pool sovereign issuance from various countries, in parallel with gradual introduction of capital surcharges on sovereign exposures. Such progress may not be sufficient, however, for national fiscal policies and monetary policy to smooth a major crisis. The introduction of common fiscal stabilisation capacity is necessary to buttress the euro area in case of a deep recession, both at the country level and euro area level. Finally, policies aiming at further cross-border integration of capital markets should reinforce private risk sharing, reducing the burden on macro policies.

English Also available in: French


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