Chapter 1. Outlook and challenges

The recovery is projected to resume after a soft patch that began in the second half of 2004. But the euro area lacks resilience against adverse shocks amid slow trend growth. Both are likely to be shaped by structural factors, as macroeconomic policy is supportive. Structural policies should aim at completing the EU’s internal market, boosting labour market performance and encouraging innovation. Fiscal policy should be rooted in longer term sustainability goals. Successful structural and fiscal policies should allow monetary policy to remain supportive in a low inflation environment. The first section of this chapter discusses the euro area’s short term performance and outlook. The following section seeks to identify the forces that have shaped the euro area’s growth performance in comparison with the best performing parts of the OECD area. The final section briefly reviews the requirements for economic policy, underpinned by analytical work reported in the subsequent chapters of this Survey.

Chapter 2. Current issues in monetary policy

Since 2000 inflation has remained close to, but mostly somewhat above the 2% mark, despite weak growth and an appreciating euro. There is little monetary policy can do on its own to boost the euro area economy: interest rate cuts are not the panacea and foreign exchange intervention appears undesirable. However, structural reforms may widen the room for monetary policy action. Greater labour market flexibility, for instance, would reduce the sacrifice ratio – the output cost of controlling inflation. Moreover, better functioning mortgage markets in the largest euro area countries, including easier access to mortgage equity withdrawal and to the refinancing of fixed rate loans, may speed up the transmission of monetary policy.

Of special interest: Illustrative estimates of the impact of owner occupied housing costs on inflation

Chapter 3. Putting the fiscal house in order

This chapter examines the experience with the EU’s fiscal framework, as laid down in the Maastricht Treaty and the Stability and Growth Pact. The main finding is that failure of several euro area countries – including the three major ones – to abide by the rules results from blurred incentives, and weak surveillance and enforcement. Addressing these problems requires greater ownership of the fiscal rules by the member countries, underpinned by solid budget institutions.

Chapter 4. Going for growth and resilience

Structural policy settings have to be improved to make the euro area more resilient against adverse shocks and to boost its potential growth. This chapter discusses the policies that have shaped the euro area’s short and long term growth as well as the policy changes that would boost growth performance. It focuses on labour market policies and the need to better integrate services markets, which are still largely segmented by country and hence leave important growth opportunities unexploited. Improving the framework conditions for innovation is also important for boosting growth. The final section quantifies the potential benefits from sustained structural reform in the aforementioned domains.

Of special interest: Integrating services markets