IMF Says Anemic Euro Zone Must Be Ready for Economic Shocks

(Bloomberg) -- The European Central Bank has limited room to safeguard the euro area’s economic expansion and governments must be ready to step in if there’s a severe downturn, according to the International Monetary Fund.

There’s a danger the 19-nation euro area is close to a prolonged period of anemic growth and inflation even in the absence of major shocks, the IMF said in its regular economic report. With rising concerns over global trade tensions, a no-deal Brexit and high public debt in some countries, it’s time for all parties to be on guard.

“Stronger policy efforts will be necessary to support growth and reduce vulnerabilities. This will not be easy, given substantial differences among countries along several dimensions, including cyclical position, fiscal space, and competitiveness. Policy makers at national and central levels need to be ready to respond with more aggressive measures if risks materialize.”
-- IMF Article IV Report

The euro zone’s slowdown started last year but has dragged on well into 2019 as trade spats between the U.S. and its partners hit confidence, dragging manufacturers into a downturn that threatens to contaminate the wider economy.

ECB President Mario Draghi said last month that he’s ready to add monetary stimulus if the outlook doesn’t improve, joining peers around the world in turning more dovish. That has raised questions though over whether central banks have gone almost as far as they can in supporting the economy, and whether governments need to play a bigger role.

IMF Managing Director Christine Lagarde will replace Draghi at the ECB in November. She’s stepped aside from her responsibilities at the fund, and First Deputy Managing Director David Lipton is currently serving in the role on an acting basis.

The institution endorsed the ECB’s decision to extend its pledge to keep interest rates at record lows, and said more monetary stimulus may be warranted. The fund suggested rates could fall further and bond purchases could be restarted.

At the same time, it said there may only be “limited room to cut rates further as diminishing returns set in.” It also doubted the effectiveness of any measures to relieve the pain on banks from the negative deposit rate, for example granting them some exemptions.

The ECB responded that strong monetary accommodation remains necessary, and said the factors holding back inflation -- such as companies compressing their profit margins instead of passing on higher costs -- will unwind over the medium term.

The IMF said countries with fiscal space “should invest in growth-enhancing spending” and that “in a severe economic downturn, greater fiscal stimulus would be needed.” It singled out Germany, saying the government should step up investment in public infrastructure, and the Netherlands. Both countries should lower taxes on labor, it said.

“Countries with fiscal space should stand ready to implement a stimulus,” the fund said.

The European Union has been criticized by economists for its rules on debt, which push nations into austerity drives that may dampen growth. The EU Commission responded to the IMF’s report by agreeing that fiscal policy should be eased further in a downturn scenario. It said “that such an easing would have to be country specific but warned about the political challenges of advising such a differentiated fiscal response.”

To contact the reporters on this story: Paul Gordon in Frankfurt at pgordon6@bloomberg.net;Carolynn Look in Frankfurt at clook4@bloomberg.net

To contact the editors responsible for this story: Paul Gordon at pgordon6@bloomberg.net, Sarah McGregor

©2019 Bloomberg L.P.