oecd economic surveys euro area · this overview is extracted from the 2016 economic survey of euro...

OECD Economic Surveys

Euro Area

June 2016

OVERVIEW

www.oecd.org/eco/surveys/economic-survey-european-

union-and-euro-area.htm

This Overview is extracted from the 2016 Economic Survey of Euro Area. The Survey is published

on the responsibility of the Economic and Development Review Committee (EDRC) of the OECD,

which is charged with the examination of the economic situation of member countries.

The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli

authorities. The use of such data by the OECD is without prejudice to the status of the Golan

Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international

law.

This document and any map included herein are without prejudice to the status of or sovereignty

over any territory, to the delimitation of international frontiers and boundaries and to the name

of any territory, city or area

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OECD Economic Surveys: Euro Area

© OECD 2016

9

Executive summary

● Monetary and financial policies to support the recovery

● Restoring credit growth

● Making public policy more supportive of inclusive growth

EXECUTIVE SUMMARY

OECD ECONOMIC SURVEYS: EURO AREA © OECD 201610

Monetary and financial policies to support the recovery

Euro area consumer prices

1. Expected average annual inflation based on the differencebetween 5 and 10-year inflation swaps.

Source: Eurostat Database and Thomson Reuters DatastreamDatabase.

1 2 http://dx.doi.org/10.1787/888933366894

Growth has picked up gradually over the pasttwo years, supported by very accommodativemonetary policy. The effect of fiscal policy ondomestic demand has turned broadly neutral. Butunemployment is still very high in many euroarea countries, investment has been sluggish andcredit remains weak. Inflation is well belowtarget and market-based measures of inflationexpectations have been drifting down. Tacklingthese interconnected problems requires resoluteand co-ordinated action by euro area countries tosupport aggregate demand and strengthen thefinancial sector to unlock credit growth.

Restoring credit growth

Credit to non-financial corporationsJanuary-March 2016

Source: ECB, Statistical Data Warehouse.1 2 http://dx.doi.org/10.1787/888933366900

Important building blocks of banking unionare now in place. But collective action is needed tocomplete banking union by further harmonisingbank regulation, reinforcing deposit insurance atthe national and European levels, and creating acommon fiscal backstop to the Single ResolutionFund. The dependence between national banksand their governments still poses a serious risk inthe event of renewed turbulence.

Making public policy more supportive of inclusive growth

Euro area fiscal stanceChange in the underlying primary balance

Source: OECD Economic Outlook, Vol. 2016, No. 1.1 2 http://dx.doi.org/10.1787/888933366912

In the wake of the global financial crisis,governments provided fiscal support and publicdebt rose sharply. Subsequent fiscal consolidationoften resulted in deep cuts to public investmentand increases in labour taxes, which weighon future growth potential. Addressing theseproblems requires applying the flexibilityembedded in the Stability and Growth Pact tosupport growth when appropriate, upgradingnational budgetary frameworks and supportingprivate investment, including in the context of theInvestment Plan for Europe.

-1

0

1

2

3

4

2012 2013 2014 2015 2016

Y-o-y % change

Total Expectations¹

-10

-5

0

5

SVN NLD IRL PRT GRC ESP ITA EA DEU FRA BEL

Annual % growth

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2004 2006 2008 2010 2012 2014

% potential GDP

EXECUTIVE SUMMARY

OECD ECONOMIC SURVEYS: EURO AREA © OECD 2016 11

MAIN FINDINGS KEY RECOMMENDATIONS

Monetary and fiscal policies

Inflation remains well under the target of below, butclose to, 2%. Inflation expectations are drifting down.

Commit to keep monetary policy accommodative untilinflation is clearly rising to near the target.

Aggregate demand is still weak and unemploymentremains very high.

Countries with fiscal space should use budgetarysupport to raise growth.

In high-debt, low-growth countries, the strict applicationof the debt reduction rule of the Stability and Growth Pactcan require very large fiscal adjustments.

Ensure that the application of the debt reduction ruleof the Stability and Growth Pact does not threaten therecovery.

Financial policies

Non-performing loans (NPLs) are still very high in somecountries, which hampers credit growth.

When NPLs create a serious economic disturbance,speed up and facilitate the resolution of NPLs by nottriggering bail-in procedures within the existing rules.

Consider establishing asset management companieswhere needed, and possibly at the European level.

Take supervisory measures to encourage banks toresolve NPLs, which might include raising capitalsurcharges for long-standing NPLs.

National fiscal positions are vulnerable to nationalbanking crises.

Reinforce national deposit insurance schemes andimplement a European Deposit Insurance Scheme, intandem with continued risk reduction in the bankingsector.

To reduce links between national governments andtheir banks, create a common fiscal backstop to theSingle Resolution Fund.

Banking regulation remains fragmented along nationalborders, which is an obstacle to a level playing field.

Further harmonise banking regulation in Europe.

Making public finances more growth-friendly

Investment in Europe remains weak. As intended in the Investment Plan for Europe, theEuropean Investment Bank should finance higher-riskprojects that would not otherwise be carried out.

Countries should increase targeted public support toinvestment while enhancing the framework conditionsfor private investment.

The composition of public spending and revenue hasbecome less growth-friendly.

Allow longer initial deadlines for correcting excessivedeficits if countries implement major structural reformsin spending and tax policies which enhance potentialgrowth and long-term sustainability.

Reforms to national budgetary frameworks have notbeen sufficient.

Adopt national expenditure rules and conduct spendingreviews linked to budget preparation.

Ensure that national independent fiscal institutionshave resources to fulfil their mandate.


© OECD 2016

13

Assessment and recommendations

● Challenges facing Europe

● Fostering recovery and rebalancing

● Keeping monetary policy accommodative

● Improving monetary transmission by resolving non-performing loans

● Completing banking union

● Making public finances more growth and equity-friendly

The statistical data for Israel are supplied by and under the responsibility of the relevant Israeliauthorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights,East Jerusalem and Israeli settlements in the West Bank under the terms of international law.

ASSESSMENT AND RECOMMENDATIONS


Challenges facing EuropeEurope has made important progress in harnessing and reinforcing its policies and

institutions to recover from a double-dip recession and improve crisis management. Very

supportive monetary policy has helped growth to pick up gradually over the past two years

(Figure 1, Panel A), and contributed to reduce tensions in sovereign debt markets (Figure 1,

Panel B). The effect of fiscal policy on demand has turned broadly neutral. Important

building blocks of banking union, on both supervision and resolution fronts, have come

into operation, improving the resilience of the European financial system. Confidence in

the European project has recovered from its lows in 2013, although it is still well below

what it was before the crisis (Figure 2).

However, many legacies of the crisis are still unresolved, and major new problems

have emerged. Unemployment is still high in many countries, and there is a wide

dispersion across the euro area (Figure 3). Despite the somewhat stronger economy,

inflation is close to zero, well below the European Central Bank (ECB) target of just

under 2%. Unlike in the United States, investment is still far below 2007 levels, especially in

those countries hit hardest by the crisis (Figure 4), mainly due to weak demand but also to

high non-performing loans and, in many countries, high corporate indebtedness, which

hamper credit (OECD, 2015a). Political tensions have flared up recently due to large inflows

of refugees, and have put strains on border-free travel within the Schengen zone. The

reintroduction of border controls in some Schengen zone countries is a setback for

European integration.

Figure 1. GDP growth and long-term interest rate spreads

1. Euro area member countries that are also members of the OECD (15 countries).2. Ten-year government bond spreads relative to the German rate.Source: OECD (2016), OECD Economic Outlook: Statistics and Projections and Main Economic Indicators (databases).

1 2 http://dx.doi.org/10.1787/888933366926

0

5

10

15

20

25

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

B. Long-term interest rate spreads2

Percentage points

GreeceIrelandItalyPortugalSpain

-5

-4

-3

-2

-1

0

1

2

3

4

2007 2008 2009 2010 2011 2012 2013 2014 2015

A. Real GDP growth in the euro area1

Percentage growth



These challenges weigh on economic performance and, more broadly, on the quality

of life of European citizens. Well-being in the euro area often displays large disparities

across countries (Figure 5). These tend to be most acute in income, labour market

outcomes and subjective well-being, all of which were deeply affected by the crisis.

Furthermore, some countries often find themselves among the best or the worst

performers in most dimensions of well-being (Figure 5). Improving well-being requires

Figure 2. Eurobarometer: Public opinion of the European UnionQuestion responses,1 per cent

1. “In general, does the EU conjure up for you a very positive, fairly positive, neutral, fairly negative or very negative image?”Source: European Commission, “Public Opinion in the European Union”, Standard Eurobarometer, various editions.

1 2 http://dx.doi.org/10.1787/888933366545

Figure 3. Unemployment dispersion in the euro areaUnemployment rates, per cent

1. Euro area 19 countries.2. Unweighted average.Source: Eurostat (2016), “Employment and unemployment (LFS)”, Eurostat Database.

1 2 http://dx.doi.org/10.1787/888933366937

0

10

20

30

40

50

60

0

10

20

30

40

50

60

2007 2008 2009 2010 2011 2012 2013 2014 2015

Total positive Neutral Total negative

0

5

10

15

20

25

0

5

10

15

20

25

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Euro area¹Average² - Greece, Portugal and SpainAverage² - Austria, Germany and Luxembourg



stronger and more even growth and job creation across the euro area, but also reforms in

specific policy areas, such as education and health, where the composition and efficiency

of public spending plays a crucial role.

Figure 4. Investment is still far below 2007 levelsReal gross fixed capital formation, index Q4 2007 = 100

1. Euro area member countries that are also members of the OECD (15 countries).Source: OECD (2016), OECD Economic Outlook: Statistics and Projections (database).

1 2 http://dx.doi.org/10.1787/888933366942

Figure 5. Well-being outcomes1

Euro area, 2016

1. Euro area member countries that are also members of the OECD (15 countries). Each well-being dimension is measured by one to threeindicators from the OECD Better Life indicator set. Normalised indicators are averaged with equal weights. Indicators are normalisedto range between 10 (best) and 0 according to the following formula: ([indicator value – worst value]/[best value – worst value]) × 10.

2. Calculated as a simple average of the highest and lowest performers of the euro area cross-country distribution.Source: OECD Better Life Index, www.oecdbetterlifeindex.org.

1 2 http://dx.doi.org/10.1787/888933366951

60

65

70

75

80

85

90

95

100

105

110

60

65

70

75

80

85

90

95

100

105

110

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

France Germany Italy Spain United States Euro area¹

0

2

4

6

8

10Income and wealth

Jobs and earnings

Housing

Work and life balance

Health status

Education and skillsSocial connections

Civic engagement and governance

Environmental quality

Personal security

Subjective well-being

Euro area Highest three results² Lowest three results²



Building a better future calls for stronger collective action on several fronts. Despite

recent progress, banking union remains incomplete, which hampers monetary policy

transmission and capital market integration, and the resulting mutual dependence of

national governments and national banks poses vulnerabilities during a crisis. Joint action

is also needed to protect external borders and share the financial burden of the refugee

inflow. Public investment remains depressed, due to strong and lopsided fiscal

consolidations in the recent past, which have fallen heavily on capital spending, and

insufficient consideration of cross-country spillovers. Business investment is further

hampered by the high levels of corporate debt overhang, by remaining weaknesses in some

national banking systems and by scant progress in goods and services markets integration

after the crisis, not least through the persistence of high regulatory heterogeneity.

In this context, the 2016 OECD Economic Survey of the euro area mainly focusses on

fiscal and financial challenges, and the 2016 OECD Economic Survey of the European Union

on structural reform priorities to complete the Single Market. The main messages of the

euro area Survey are:

● To deal with the problems they face, member states need to harness European

institutions to develop and implement collective and co-operative solutions.

● The euro area economy is gradually recovering, but investment remains weak and the

wide disparity in economic performance and well-being is still a major concern.

● Collectively strengthening aggregate demand and financial sector performance will be

critical to ensuring that growth picks up and unemployment continues to decline.

Fostering recovery and rebalancingGrowth has gathered pace since mid-2014, supported by successive rounds of

monetary expansion (Figure 6). The sharp fall in global oil prices has raised household

incomes and fiscal policy is no longer weighing on domestic demand. Exports grew

robustly for several quarters, reflecting the euro depreciation and stronger activity in major

markets, such as the United Kingdom and the United States. More recently, a stronger euro

and the slowdown in emerging markets have made export growth decelerate markedly.

Business investment has disappointed, largely due to weak growth expectations and, in

some countries, credit constraints.

Economic performance has been uneven from country to country. The sovereign debt

crisis and the associated large fiscal and macroeconomic adjustment efforts by the

countries hit hardest (e.g. Greece, Ireland, Italy, Portugal and Spain) led to very divergent

output and unemployment developments across the euro area. This divergence has been

modestly reversed over the past two years, with some of those countries recording

above-average growth. Despite narrowing interest rate differentials and significant

reductions in lending rates, credit and investment in most of those countries have

remained hampered by high non-performing loans and corporate debt (Figure 7), and

incomplete capital market integration. The exceptions have been Ireland, where large

multinationals do not depend on domestic banks for financing, and Spain, which has made

significant progress in cleaning up banks’ balance sheets.

External positions are rebalancing, but the process has been asymmetric and

incomplete, and has left the euro area as a whole with a large external surplus. Germany

and the Netherlands have further increased their already significant surpluses. The

countries hit hardest by the global financial and euro area crises have all eliminated



significant current account deficits, although, in spite of structural improvement, this also

reflects still weak domestic demand and, therefore, imports (Figure 8). The same countries

also improved cost competitiveness (Figure 9), in the context of substantial output losses.

Apart from Greece and Italy, export performance has improved as a result. However, a

number of these countries continue to display poor net international investment positions,

and improving them will require sustained GDP growth and current account surpluses in

the medium and long run. Stronger wage and internal demand growth in surplus countries

will ease further rebalancing and make it more symmetric, not least by reversing the

persistent decline in their relative unit labour costs (Figure 9).

Labour market developments have also varied markedly across countries. As euro area

unemployment started to increase in 2008, so did its dispersion across countries, which

has only fallen slightly recently (Figure 3). Moreover, especially in the countries hit hardest

by the crisis, estimates of structural unemployment have risen (Ollivaud and Turner, 2014)

Figure 6. Activity has gradually recovered but sharp cross-country divergence remains

1. Euro area member countries that are also members of the OECD (15 countries).Source: OECD (2016), OECD Economic Outlook: Statistics and Projections and Main Economic Indicators (databases); and Eurostat (2016),“Employment and unemployment (LFS)”, Eurostat Database.

1 2 http://dx.doi.org/10.1787/888933366963

90

95

100

105

110

115

120

0

25

50

75

100

125

150

2012 2013 2014 2015 2016

2010 = 100USD/barrel

B. Oil price and effective exchange rate

Oil spot price (Brent, left axis)Nominal effective exchange rate (right axis)

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

2012 2013 2014 2015 2016

A. Activity in the euro area1

% change over previous quarter, volume

GDPTotal investmentExports of goods and services

0

5

10

15

20

25

30

DEU IRL FRA EA¹ ITA PRT ESP GRC

C. Unemployment rates Per cent

2013 2015

70

75

80

85

90

95

100

105

110

115

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

D. Real GDP Index Q4 2007 = 100

GermanyGreeceIrelandItalyPortugalSpain



and the labour force has fallen as workers have become discouraged and, in some

countries, have emigrated in search of better job opportunities (OECD, 2015b). Conversely,

Germany has benefited from lower unemployment and an increased labour force.

Unsurprisingly, poverty has tended to increase more in those countries with large hikes in

joblessness (Figure 10). Furthermore, recent consolidation efforts in the countries most

affected by the crisis have sometimes included deep cuts to unemployment benefits (see

Chapter 1), which have likely worsened distributional impacts.

Figure 7. Debt of non-financial corporations in the euro area1

As a percentage of GDP

1. Debt is calculated as the sum of the following liability categories, whenever available/applicable: special drawing rights; currency anddeposits; debt securities; loans; insurance, pension, and standardised guarantees; and other accounts payable.

2. Unweighted average of data for euro area member countries that are also members of the OECD (15 countries).Source: OECD (2016), “Financial Dashboard”, OECD National Accounts Statistics (database).

1 2 http://dx.doi.org/10.1787/888933366974

Figure 8. Indicators of external balanceAs a percentage of GDP

Source: Eurostat (2016), “Balance of payments statistics and international investment positions (BPM6)”, Eurostat Database.1 2 http://dx.doi.org/10.1787/888933366980

0

50

100

150

200

250

300

350

400

450

0

50

100

150

200

250

300

350

400

450

GRC SVK DEU AUT ITA SVN FIN EST NLD ESP FRA EA² BEL PRT IRL LUX

2014 2008

-16

-12

-8

-4

0

4

8

12

GRC PRT ESP IRL ITA FRA NLD DEU

A. Current account balance

2008 2015

-150

-125

-100

-75

-50

-25

0

25

50

75

PRT IRL ESP GRC ITA FRA NLD DEU

B. Net international investment position

2008 2015



Gross domestic product (GDP) growth for the euro area as a whole is projected to

accelerate modestly to close to 2% (Table 1). Activity will continue to be supported by

sustained monetary stimulus, a broadly neutral fiscal stance and lower oil prices. However,

high private indebtedness will remain a drag on consumption and investment in many

countries, and falling demand from emerging economies will weigh on exports.

Unemployment will decline only gradually, and the stark differences across countries will

persist. Inflation is projected to edge up to about 1% by 2017 as the effects of cheaper

energy wane and cyclical slack gradually decreases.

A stronger-than-projected slowdown in China and other emerging market economies

would weaken demand in the euro area through several channels. Impacts through trade

linkages alone would likely be small (about 0.1% of GDP per percentage point fall in Chinese

Figure 9. Export performance and competitivenessIndex, Q1 1999 = 100

1. Real harmonised competitiveness indicator for unit labour costs in total economy.2. Ratio between export volumes and export markets for total goods and services.Source: OECD (2016), OECD Economic Outlook: Statistics and Projections (database); and ECB (2016), Statistical Data Warehouse, EuropeanCentral Bank.

1 2 http://dx.doi.org/10.1787/888933366617

A. Relative unit labour costs1

B. Export performance2

60

70

80

90

100

110

120

130

140

150

160

1999 2001 2003 2005 2007 2009 2011 2013 2015

France GermanyItaly Spain

80

90

100

110

120

130

140

1999 2001 2003 2005 2007 2009 2011 2013 2015


80

90

100

110

120

130

140

1999 2001 2003 2005 2007 2009 2011 2013 2015

Greece IrelandPortugal Slovenia

60

70

80

90

100

110

120

130

140

150

160

1999 2001 2003 2005 2007 2009 2011 2013 2015




domestic demand), as even the whole of Asia accounts for only 12% of euro area goods

exports. However, repercussions on euro area GDP could increase by a factor of three if the

demand slowdown in China led to adjustments in global financial markets, such as higher

risk premia (OECD, 2015c). Through cheaper commodities and pressures for euro

appreciation, a slowdown would also make it more difficult to steer euro area inflation

towards 2%. While tail risks of financial stress have receded, the outcome of the upcoming

referendum in the United Kingdom could have important implications for economic

performance in both the United Kingdom and the rest of Europe (Kierzenkowski et al.,

2016). The refugee crisis is already straining the Schengen agreement and might even

affect the free flow of goods and, especially, labour in Europe. This could to some extent

reduce the benefits of the single market and shake confidence in the European Union more

generally. There is considerable uncertainty regarding the inflation projection, and a more

long-lasting period of low inflation, or even falling prices, cannot be ruled out. This could

make debt burdens more difficult to manage and, for the countries hit hardest by the crisis,

further competitiveness gains harder to achieve, delaying the recovery.

On the other hand, more rapid progress in fiscal and structural reforms would boost

growth relative to the projection. Of particular importance are collective fiscal action

within the Stability and Growth Pact rules to boost investment and growth, the banking

union and further progress on the single market. A resolution of the refugee crisis would

bolster confidence in the EU institutional framework and thereby improve growth

prospects. Recent and potential future policy moves by the ECB may prove more effective

in raising inflation towards its target than assumed. Similarly, cheap oil may have a

stronger-than-expected impact on demand.

Figure 10. Developments in unemployment and povertyPercentage points

1. The poverty rate is the share of persons with disposable income (equivalised for family size) below 60% of national median disposableincome.

2. Euro area 19 countries.Source: Eurostat (2016), “Income distribution and monetary poverty” and “Unemployment and employment (LFS)”, Eurostat Database.

1 2 http://dx.doi.org/10.1787/888933366993

-5

0

5

10

15

20

DEU LU

X

AUT

BEL

FIN

FRA

EST

NLD EA

²

SVK

ITA

SVN

IRL

PRT

ESP

GR

C

A. Unemployment rate Change 2008-13

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

FIN

AUT

FRA

NLD IR

L

BEL

EA²

ITA

DEU LU

X

SVK

PRT

ESP

EST

GR

C

SVN

B. Poverty rate1

Change 2009-14



Keeping monetary policy accommodativeFollowing the outset of the financial crisis in September 2008 and the ensuing

long period of low growth, the European Central Bank (ECB) successively cut its policy rates

– except during a short period in 2011 – to their lowest levels since it started operating: the

deposit rate has been negative since mid-2014 (Figure 11, Panel A). However, if assessed

through the evolution of the real short-term market interest rate, monetary policy became

less accommodative in 2013-14 (Figure 11, Panel B). This is explained by the fall in inflation

since late 2011 (see below).

The use of unconventional monetary tools diminished in 2013 and 2014, as most

commercial banks started reimbursing the loans they took under the long-term refinancing

operations (LTROs). As a result, the Eurosystem balance sheet shrank significantly from

30% of GDP end-2012 to about 20% end-2014 (Figure 12). Persistent undershooting of

Table 1. Macroeconomic indicators and projectionsEuro area,1 annual percentage change, volume (2011 prices)

2013 2014 2015Projections

2016 2017

Gross domestic product (GDP) -0.3 1.0 1.6 1.6 1.7

Private consumption -0.6 0.8 1.6 1.8 1.7

Government consumption 0.2 0.8 1.3 1.7 1.1

Gross fixed capital formation -2.5 1.4 2.6 3.3 3.2

Final domestic demand -0.8 0.9 1.8 2.1 1.9

Stockbuilding2 0.2 0.0 0.0 0.1 0.0

Total domestic demand -0.7 1.0 1.7 2.2 1.9

Exports of goods and services 2.2 4.1 5.2 3.0 4.1

Imports of goods and services 1.3 4.5 6.0 4.4 4.6

Net exports2 0.4 0.0 -0.1 -0.4 -0.1

Other indicators (growth rates, unless specified)

Potential GDP 0.6 0.7 0.8 0.9 1.0

Output gap3 -3.2 -2.9 -2.2 -1.5 -0.7

Employment -0.6 0.6 1.0 1.3 1.0

Unemployment rate 11.9 11.5 10.8 10.2 9.8

GDP deflator 1.3 0.8 1.2 0.9 1.1

Consumer price index (harmonised) 1.3 0.4 0.0 0.2 1.2

Core consumer prices (harmonised) 1.1 0.8 0.8 0.9 1.1

Household saving ratio, net4 6.3 6.4 6.4 6.7 6.6

Current account balance5 2.9 3.1 3.8 3.8 3.6

General government fiscal balance5 -3.0 -2.6 -2.1 -1.8 -1.4

Underlying general government fiscal balance3 -1.0 -0.8 -0.8 -1.0 -1.0

Underlying general government primary fiscal balance3 1.3 1.4 1.3 0.9 0.7

General government gross debt (Maastricht)5 93.7 94.7 93.3 92.4 91.3

General government net debt5 66.1 72.5 72.0 72.0 71.5

Three-month money market rate, average 0.2 0.2 0.0 -0.2 -0.3

Ten-year government bond yield, average 2.9 2.0 1.1 0.9 0.8

Memorandum item

Gross government debt5 105.2 112.1 110.5 109.6 108.5

1. Euro area member countries that are also members of the OECD (15 countries).2. Contribution to changes in real GDP.3. As a percentage of potential GDP.4. As a percentage of household disposable income.5. As a percentage of GDP.Source: OECD (2016), “OECD Economic Outlook No. 99”, OECD Economic Outlook: Statistics and Projections (database).



inflation led the Governing Council to reinvigorate the use of unconventional tools as of

mid-2014, and most recently in March 2016. Measures have included a combination of

conventional monetary policy easing, taking the deposit rate increasingly to negative

territory, credit easing in the form of a series of targeted long-term refinancing operations

(TLTROs), and quantitative easing through an asset purchase programme (APP) that initially

comprised asset-backed securities and covered bonds and increased in scope to include

sovereign bonds (from March 2015) and non-bank corporate bonds (from June 2016).

Figure 11. Interest rate developmentsPer cent

1. Three-month rate deflated by the harmonised consumer price index.Source: ECB (2016), “Statistics Bulletin”, Statistical Data Warehouse, European Central Bank; and OECD (2016), OECD Economic Outlook:Statistics and Projections (database).

1 2 http://dx.doi.org/10.1787/888933367000

Figure 12. Central banks’ total liabilitiesEnd of period data, as a percentage of GDP

1. Estimate for 2016 second quarter onwards based on monthly increases of EUR 80 billion.Source: Thomson Reuters (2016), Datastream Database; and OECD (2016), OECD Economic Outlook: Statistics and Projections (database).

1 2 http://dx.doi.org/10.1787/888933367019

-1

0

1

2

3

4

5

6

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

A. Key ECB interest rates

Deposit rateMarginal lending rateMain refinancing rate

-3

-2

-1

0

1

2

3

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

B. Real short-term interest rate1

0

10

20

30

40

50

60

70

80

90

0

10

20

30

40

50

60

70

80

90

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Euro area¹ United States Japan United Kingdom



The asset purchase programme consists of purchasing various eligible assets, both

private (asset-backed securities, covered bonds and non-financial corporate bonds) and

public (such as government, agencies and European institutions bonds, under the so-called

public sector purchase programme), at an original pace of EUR 60 billion per month,

making it an effective quantitative easing (QE) programme. The initial intention was to

carry out purchases at least till September 2016, but on 3 December 2015 the Governing

Council extended it to March 2017 or beyond, if necessary, and increased the pool of eligible

assets, notably by including regional and local government debt. The size of monthly

purchases was increased to EUR 80 billion in March 2016 and the pool of eligible assets was

widened further to investment grade bonds issued by non-bank firms. The balance sheet

of the ECB is expected to reach close to 40% of euro area GDP by March 2017 (Figure 12).

The effectiveness and timing of quantitative easing policies has been highly debated

(IMF, 2013). However, since the announcement of the programme to the end of the first

quarter of 2015, the valuation of European stock exchanges increased by about 20% and the

euro effective exchange rate depreciated by about 10% (Figure 13). In addition, the asset

purchase programme has helped spreads of sovereign bonds in peripheral countries to

remain low (despite some renewed financial market stress around Greece in 2015), which

is facilitating the recovery in those countries. Based on a macroeconomic model simulation

(NiGEM), a 10% depreciation of the euro could increase inflation by ¾ percentage point and

growth by about 1¼ percentage points in the following year. Using the same model, the

impact of an increase in stock prices of 20% would be more moderate, about ½ percentage

point on activity and none on inflation.

Despite quantitative easing, inflation (total and core) and swaps-based inflation

expectations are now well below the inflation target of the ECB (Figure 14). Temporary

factors, such as the significant drop in oil prices and cheaper imports, notably from China,

Figure 13. Financial indicatorsIndex, 2010 = 100

1. Dow Jones EURO STOXX Broad Benchmark Index.2. ECB announcement (22 January 2015), recalibration (3 December 2015) and expansion (10 March 2016) of the Asset Purchase

Programme (APP).Source: OECD (2016), OECD Economic Outlook: Statistics and Projections and Main Economic Indicators (databases).

1 2 http://dx.doi.org/10.1787/888933367029

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2012 2013 2014 2015 2016

Nominal effective exchange rate Share price index¹

APP dates²



help explain this low inflation rate, but only to a certain extent. For example, the steep fall

in the price of Brent by almost USD 40 per barrel in 2015 would have reduced headline

inflation by only about ¼ percentage point in 2015, based on a NiGEM simulation.

The transmission of monetary policy has improved and interest rates of corporate loans

have been converging in the past two years. However, for loans of smaller size, which matter

more for small and medium-sized enterprises (SMEs), rates remain 1 or 2 percentage points

higher in some countries (Figure 15, Panels A and B). While part of this differential reflects

differences in macroeconomic risk among euro area countries, this could also indicate that

firms with similar risk profile, and especially SMEs, tend to suffer from higher lending costs

depending on the country in which they are located. This could be explained by the still

fragile situation of many banks in some countries, which are plagued with high levels of

non-performing loans (NPLs, see below). Banks with high levels of NPLs tend to lend less as

they are less profitable, have weaker capital buffers and higher funding costs (Aiyar et al.,

2015). As a result, credit is still falling, though more slowly, in most of those countries

(Figure 15, Panel C). In a well-functioning single market, the impact of weak domestic banks

or high sovereign risk premia should be minimal as creditworthy firms should be able to get

financing from other banks or channels (Coeuré, 2015).

With inflation still low, inflation expectations falling and slack still large, monetary

policy needs to remain firmly committed to an expansionary stance. Based on current

OECD projections, inflation is set to remain below the ECB target until end-2017. In this

context, the ECB should explicitly commit to keep monetary policy accommodative (i.e. not

increase interest rates or shrink its balance sheet) and treat risks to the achievement of its

inflation target symmetrically. In fact, explicitly accepting that inflation could go beyond

2% over the next two years without triggering a tightening of monetary policy could make

monetary policy more effective at influencing expectations, which is crucial when interest

rates are at the zero lower bound (Ambler, 2009). Nor would it necessarily reduce credibility.

Figure 14. Inflation developmentsYear-on-year percentage change

1. Harmonised indices of consumer prices; core inflation excludes energy, food, alcohol and tobacco.2. Expected average annual inflation based on the difference between 5-year and 10-year inflation swaps.3. European Central Bank announcement of an expanded Asset Purchase Programme (APP).Source: Eurostat (2016), “Harmonised indices of consumer prices”, Eurostat Database; and Thomson Reuters (2016), Datastream Database.

1 2 http://dx.doi.org/10.1787/888933366894

-1.0

-0.5

0.0

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2008 2009 2010 2011 2012 2013 2014 2015 2016

Total¹ Core¹ Expectations²

Expanded APP³ 22 January 2015



The ECB should ease further if inflation remains below target for longer than expected,

for instance in the event of negative economic shocks. The ECB could envisage additional

rate cuts, notably the deposit rate as it is the most important policy rate in an environment

of excess liquidity, although it would be necessary to carefully assess whether the risks of

lowering bank profitability are still of second order compared to the need to sustain the

recovery (Coeuré, 2014). Expanding the use of TLTRO is a key tool to reduce impairment in

Figure 15. Credit developments and financial fragmentationNon-financial corporations

1. New business loans with an initial rate fixation period of less than one year. Loans other than revolving loans and overdrafts,convenience and extended credit card debt.

Source: ECB (2016), “Balance sheet items” and “MFI interest rate statistics”, Statistical Data Warehouse, European Central Bank.1 2 http://dx.doi.org/10.1787/888933367037

A. Interest rates on loans of up to and including EUR 1 million1

Per cent

B. Interest rates on loans of over EUR 1 million1

Per cent

C. Loans adjusted for sales and securitisation Year-on-year percentage change

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the transmission of monetary policy and to enhance the provision of credit. The impact of

the APP could be strengthened further by increasing again the monthly purchases, which

may require a new extension of eligible assets.

Macroeconomic imbalances linked to the very expansionary monetary stance seem so

far limited. There is no indication at this stage of asset price bubbles at the euro area level,

notably in the housing sector (Figure 16). Nevertheless, macro-prudential tools should be

strengthened to avoid the reappearance of bubbles, which could also apply to EU countries

outside the euro area as they could face high capital flows resulting from quantitative

easing policies (Rey, 2015). In the housing sector, for example, lower loan-to-value or

loan-to-income criteria could be imposed.

Improving monetary transmission by resolving non-performing loansOn the banking sector side, a more aggressive policy to resolve the high level of

non-performing loans (NPLs) in several countries would improve banks’ financial situation,

facilitating monetary policy transmission and, hence, credit expansion. NPLs are still very

high in several countries (Figure 17). Comparing the level of NPLs is difficult, despite the

introduction by the European Banking Authority (EBA) in October 2013 of a harmonised

definition, as it has mainly applied to the larger banks so far (Aiyar et al., 2015). Swift

resolution of NPLs, before the value of impaired loans or their collaterals becomes too low,

is a key element needed to reallocate credit more productively to other firms. This is also a

financial stability issue as banks in many euro area countries would suffer significant

capital losses if the value of their collateral were to fall substantially (Figure 18).

To that end, banks should be encouraged to provision more on a case-by-case basis.

Since current International Financial Reporting Standards (IFRS) do not require “dynamic”

provisioning (i.e. using a forward-looking model of expected losses) before 2018, the

regulator could consider other options, such as imposing capital surcharges. Such

additional capital requirements could be triggered once NPLs have passed a certain period,

Figure 16. House pricesEuro area,1 index

1. Euro area member countries that are also members of the OECD (15 countries).Source: OECD (2016), Analytical House Price Indicators (database).

1 2 http://dx.doi.org/10.1787/888933367049

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2007 2008 2009 2010 2011 2012 2013 2014 2015

Long-term average = 1002010 = 100

Real house prices (left axis) Price to income ratio (right axis) Price to rent ratio (right axis)



for example through higher risk weights. Still another way to encourage provisioning could

be to impose a progressive reduction of the value of loan collateral past a certain duration:

this was applied by the Bank of Spain for NPLs more than two years old.

Figure 17. Non-performing loansGross non-performing debt instruments as a percentage of total gross debt instruments

1. Average of first three quarters.Source: ECB (2016), “Monetary and financial statistics”, Statistical Data Warehouse, European Central Bank.

1 2 http://dx.doi.org/10.1787/888933367053

Figure 18. Non-performing loans net of provisions to capitalAs a percentage of capital, Q4 20151

1. Data is end of period. 2013 for Finland and Luxembourg; 2014 for Germany, Korea and the United Kingdom; Q2 or Q3 2015 for Belgium,Italy, Japan and Switzerland. Aggregates are unweighted averages of the latest data available and OECD covers 31 countries. Theprecise definition and consolidation basis of non-performing loans may vary across countries.

2. Euro area 19 countries.Source: IMF (2016), Financial Soundness Indicators (FSI Database), International Monetary Fund.

1 2 http://dx.doi.org/10.1787/888933367060

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Greece IrelandNetherlands Portugal

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In parallel to increasing the costs for banks to keep NPLs, policies should also create

instruments for banks to recover the highest possible value from their impaired loans. One

avenue is to improve insolvency procedures. In particular, they should be made faster in

many euro area countries, for example by using out-of-court procedures: fast resolution is

key to preserve the value of collateral, especially for firms whose collateral tends to

depreciate rapidly through obsolescence. In some countries, legal procedures for banks to

access collateral are unduly long.

Setting up an asset management company (AMC) can be a very efficient tool to resolve

NPLs: such companies bring better knowledge to value impaired assets, which allows

banks, especially smaller ones, to get a better price. A company set at the European level

would maximise economies of scale and diversify asset recovery risks. At the same time,

potential cross-country risk sharing could be compensated by some financial sector

conditionality applied to countries benefiting from the European AMC. An alternative

option would be to continue setting up AMCs at the national level. However, public capital

may be needed to facilitate private sector participation. Under the new bank recovery and

resolution directive (BRRD), selling assets to the AMC above market price (which is

considered state aid) triggers a bail-in of junior creditors, the implementation of a

restructuring plan for the bank, and, since January 2016, possibly a bail-in of senior

creditors as well. Some of these senior bonds have been sold by banks to retail customers,

which creates a significant hurdle for governments in some countries to move in that

direction. Given the systemic and financial stability considerations in countries where the

NPL problem encompasses large swathes of the banking sector, bank-level resolution

considerations should not dominate, even if banks having structural viability problems

should be restructured.

To facilitate the creation of AMCs, measures to treat NPLs on bank balance sheets

within the existing rules without triggering bail-in and resolution procedures should be

examined, including possible initiatives at the European level. A very high level of NPLs

should be considered a serious economic disturbance and warrant such a waiver to bail-in

and resolution procedures within the existing rules. Alternatively, a more lenient approach

in the definition of the price level triggering state aid – and hence resolution – could be

applied. Both approaches would have to be weighed carefully against moral hazard effects

and the possible exacerbation of the sovereign-bank nexus. Currently, the European

Commission considers that there is state aid – hence triggering resolution – for any

purchase of the NPL by a state-supported AMC at a price above the estimated “market

price” of the NPL. Alternatively, when market prices are uncertain and depressed by

stressed conditions, resolution requirements could be applicable only for prices above a

level half way between the “market price” and the “real economic value” (the latter being

the ceiling above which purchases of NPLs by a state-supported AMC are prohibited).

Member states benefitting from this exceptional treatment could in return be required to

make their insolvency regimes more efficient, which would facilitate a faster recovery of

collaterals and thus enable the AMCs to get a higher price for impaired assets.

Completing banking unionDespite recent progress, banking union is still unfinished business. Additional,

mutually-reinforcing steps in the areas of supervision, resolution and deposit insurance

are required. By curbing the still large potential for negative feedback loops between banks

and their sovereigns, completing the banking union would considerably ease crisis



management. Together with steps to create a Capital Markets Union, it would also foster

capital markets integration, with benefits for monetary policy transmission, private

risk-sharing and rebalancing across the euro area. Furthermore, many of these channels,

together with decreased uncertainty brought about by a more complete Economic and

Monetary Union, would spur investment and demand in Europe.

The Single Supervisory Mechanism (SSM), comprising the ECB and the competentnational authorities, came into operation in November 2014. The ECB directly supervisesabout 130 large banks, which account for over 80% of euro area banking assets, andoversees the supervisory activities of the competent national authorities on other banks.However, the regulatory framework remains fragmented by numerous options anddiscretions in the way national supervisors or legislators implement the EU banking law,which inter alia creates obstacles to harmonised supervision and cross-border bankingconsolidation in Europe. Recent harmonisation work by the ECB is expected to tackle about120 options and discretions in the supervisory remit through an ECB regulation plusguidance to supervisory teams for decisions on a case-by-case basis (ECB, 2015). A levelplaying field, however, also depends on national legislation, both in banking law and inrelated matters, such as insolvency regimes.

Beyond harmonisation, the EU banking law treatment of sovereign exposures, nowgenerally zero-risk weighted and exempted from large exposure limits, is under review.However, to avoid disruptions to sovereign debt markets and government financing,changes in regulation in this area should follow a co-ordinated approach at global level andrequire careful consideration of transition arrangements (ESRB, 2015).

The Single Resolution Mechanism became fully operational in January 2016, asplanned, with a resolution authority (the Single Resolution Board), a harmonisedframework for resolution tools (the Bank Recovery and Resolution Directive) and dedicatedfinancial resources (the Single Resolution Fund). Bailing in shareholders and creditors by atleast 8% of total liabilities (including own funds) is in general a pre-condition for access tothe Single Resolution Fund. Over an eight-year transition period, this Fund will be built upwith risk-adjusted contributions from banks, and its national compartments will begradually mutualised. By end-2023, it should reach 1% of covered deposits in participatingmember states (an estimated EUR 55 billion). During the transition period, national creditlines will back up national compartments.

Further progress at both national and European levels is needed on deposit insurance.The 2014 Deposit Guarantee Schemes Directive further harmonised coverage, sped uppay-out to depositors and strengthened funding requirements for national schemes, whichare in general to be built-up to a minimum 0.8% of insured deposits by 2024. However, dueto different starting points, transposition delays (most countries missed the July 2015deadline) and remaining options and discretions, actual funding levels still vary widely.While desirable in its own right, reinforcing national insurance schemes through fullimplementation of the 2014 directive would also help to pave the way for mutualisedarea-wide insurance by decreasing moral hazard concerns.

Even when fully built-up, national deposit guarantee schemes will remain vulnerable

to large national shocks, an issue that mutualisation would mitigate. A recent

European Commission proposal for a European Deposit Insurance Scheme, to be phased in

over 2017-24, is a welcome step (European Commission, 2015a, 2015b). Overall costs for

banks would not change, as contributions to the European Deposit Insurance Scheme

would gradually replace those to national schemes, and the funding target of 0.8% of



covered deposits by 2024 would also remain unchanged. Moreover, bank contributions

would better reflect risk, since they would be calculated relative to all other participating

banks, rather than in relation to individual national banking systems. Equally welcome is

the pre-condition of further harmonisation of national schemes, in aspects like target

levels of funding and determination of risk-adjusted bank contributions.

To complete the banking union, it is necessary to introduce a European fiscal backstop

to the Single Resolution Fund and to the European Deposit Insurance Scheme, once it is

implemented. Layers of defence have been put in place in recent years, such as higher

capital requirements, enhanced supervision and bail-in provisions. Yet the Single

Resolution Fund, small even when fully built-up, could be insufficient to cope with a large

banking crisis (CEPS, 2014). The direct bank recapitalisation instrument of the European

Stability Mechanism, operational since December 2014 and designed as a last-resort tool

after Single Resolution Fund intervention, provides only a partial solution. Amounts

dedicated to this instrument are also limited (EUR 60 billion) and eligibility criteria are

restrictive (Juncker et al., 2015), as they require national co-financing and could include

general economic policy conditionality. A common backstop could be implemented

through a credit line from the European Stability Mechanism to the Single Resolution Fund,

and would be fiscally neutral in the medium term as banks would reimburse any public

funds used through ex post contributions to the Single Resolution Fund. By breaking the

banks-sovereign nexus at national level, a European fiscal backstop would also ease

acceptance of tighter supervisory harmonisation (Schoenmaker and Wolff, 2015).

Making public finances more growth and equity-friendlyThe crisis has taken a heavy toll on public finances, calling for reforms at Europeanand national level

Public finances matter for growth and equity through multiple channels. Ensuring

debt sustainability and smoothing cyclical fluctuations tend to support growth in mutually

reinforcing ways. High levels of debt can hamper the ability to stabilise the economy (Fall

and Fournier, 2015). In turn, deep recessions can harm long-term growth and thus

compound sustainability challenges through hysteresis effects. By increasing long-term

unemployment, these effects will also likely worsen inequality.

Certain changes in the composition of expenditure or revenue can significantly enhance

growth (IMF, 2015a). Examples include a greater prioritisation of public investment or

education, or a shift of taxation from labour to consumption and property (Johansson et al.,

2008; Cournède et al., 2013). More qualitative fiscal-structural reforms, such as base-

broadening in taxation to fund tax rate decreases or greater efficiency in spending, would

also be growth-friendly. At the same time, some compositional changes may harm equity,

but others, such as those favouring education and childcare spending, enhance it.

Sustainability, cyclicality, composition and efficiency are hence interconnected

dimensions of the overall quality of public finances. However, several of these dimensions

have deteriorated since the global financial crisis. The increase in public debt was

substantial (Figure 19), largely due to the recession and to specific events, such as banking

sector rescues (Eyraud and Wu, 2015). High debt can weaken fiscal sustainability including

by triggering shifts in market sentiment, which could make debt financing more difficult.

Further, although without firm conclusions on the direction of causality (e.g. Panizza and

Presbitero, 2014), high debt levels tend to be associated with lower GDP growth. Concerns

about high and rising debt, together with market pressure in some instances, led to sharp



fiscal consolidation in the euro area as a whole, especially in 2011 and 2012, and to a lesser

extent 2013 (Figure 20). Consolidation partly reflected earlier commitments in the context

of the 2008-09 co-ordinated fiscal stimulus package. Although estimates of the importance

of spillovers vary across studies, fiscal consolidation in one country can have a sizeable

negative growth impact on others, especially in bad times (Goujard, 2013; Carnot and

Castro, 2015). As a result, the simultaneous fiscal adjustment across the euro area,

including in core countries, is considered to have made the recession deeper and longer

(Baldwin et al., 2015). This likely aggravated the debt-GDP ratio as growth was weaker.

Figure 19. Evolution of gross public debt in the euro area1

Maastricht definition, as a percentage of GDP

1. Euro area member countries that are also members of the OECD (15 countries).Source: OECD (2016), “OECD Economic Outlook No. 99”, OECD Economic Outlook: Statistics and Projections (database).

1 2 http://dx.doi.org/10.1787/888933367075

Figure 20. The fiscal stance in the euro area1

Change in the underlying balance as a share of potential GDP, percentage points

1. Euro area member countries that are also members of the OECD (15 countries).Source: OECD (2016), OECD Economic Outlook: Statistics and Projections (database).

1 2 http://dx.doi.org/10.1787/888933366912

60

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

-1.5

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2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015



Furthermore, shifts in budget composition have generally hurt medium-term growth

prospects, especially in the countries carrying out the largest fiscal adjustments. Spending

restraint has fallen heavily on public investment (Figure 21). Several countries, especially

those hit hardest by the crisis, also cut social protection expenditures on family and

children, although this spending tends to be growth and equity-friendly. Developments

in revenue composition have been less harmful, but still a matter of concern. Social

contributions have tended to account for a modest share of the adjustment, which is

welcome, but personal income taxes have increased significantly in many countries. These

increases can potentially make income distribution less unequal but tend to penalise

employment and growth. Worryingly, labour tax wedges in euro area countries, already

high in international comparison, have tended to rise further, and those on low incomes

have sometimes risen the most (Figure 21). A recent stock-taking of reforms shows that

many euro area countries are planning or implementing labour tax reductions, though

measures could be more ambitious (European Commission, 2015c).

These developments in government revenue and spending have gone hand in hand

with only a modest degree of implementation of fiscal-structural reforms that improve the

composition or efficiency of public finances. Action in response to country-specific

recommendations addressed to countries by the European institutions has on average

been relatively low, and below-average in fiscal-structural policy areas (Deroose and

Griesse, 2014). For instance, there has been limited progress in reducing taxes on

labour and broadening tax bases. On the spending side, reforms to strengthen public

administration governance and to improve cost-effectiveness and performance in key

domains, such as education and health, have also tended to display below-average

implementation.

While most policy levers to improve the quality of public finances remain at the

national level, European and national policies can be mutually reinforcing in two key areas:

fiscal governance and public investment. Fiscal governance matters for virtually all

dimensions of the quality of public finances. Especially since the crisis, numerical fiscal

rules have striven to reconcile sustainability and stabilisation (Schaechter et al., 2012).

Other desirable features of fiscal governance, such as a multi-year budget horizon and

independent fiscal institutions, can enhance the effectiveness of numerical rules and yield

benefits for the composition and efficiency of public finances. For instance, better budget

institutions tend to lead to more growth-friendly fiscal consolidation (IMF, 2014; Gonçalves

and Pina, 2016). Multi-year budget frameworks, as encouraged by recent Stability and

Growth Pact (SGP) reforms, help optimise public investment (IMF, 2015b), which is one of

the fiscal tools with the strongest impacts on growth. Collective action to increase public

capital formation and leverage private investment is critical to overcome persistent

investment weakness in Europe and spur growth both in the short and the medium run.

Especially in the latter horizon, the Investment Plan for Europe, in articulation with

national resources and with other instruments at EU level, such as regional policy funds,

may play an important role.

Reforming European fiscal governance to promote collective and inclusive growth

Fiscal policy remains a key competency at the national level. At the same time, national

budgets are also subject to the requirements of the Stability and Growth Pact (SGP). The SGP

has a dual structure, with a corrective arm and a preventive arm. The first, also called the

Excessive Deficit Procedure (EDP), is based on ceilings for the nominal deficit and debt as a



Figure 21. Post-crisis fiscal consolidation episodes: Compositionand labour tax wedge developments1

1. A fiscal consolidation episode is a period of consecutive years where the underlying primary balance is improving. A deterioration ofthis balance in an intermediate year is admissible, provided the balance improves in the sum of any two adjacent years. Episodesconsidered in the chart are those starting in 2009 or later. Due to data limitations on the composition of consolidation, the final yearconsidered is 2013, though for some countries consolidation efforts have continued afterwards.

2. On both revenue and expenditure sides, increases or decreases in cyclically-adjusted budget items do not always relate todiscretionary policy measures. For instance, tax elasticities can fluctuate for reasons not captured by the corrections performed forthe economic cycle and for one-offs.

3. Income tax plus employee and employer contributions less cash benefits as a percentage of labour costs.Source: D. Gonçalves and Á. Pina (2016), “The composition of fiscal consolidation episodes: Impacts and determinants” and D. Bloch et al.(2016), “Trends in public finance: Insights from a new detailed dataset”, both OECD Economics Department Working Papers, forthcoming; andOECD (2016), “Taxing Wages: Comparative tables”, OECD Tax Statistics (database).

1 2 http://dx.doi.org/10.1787/888933367086

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Public investment Other Total primary expenditure

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ITA20102012

LUX20112012

NLD20122013

PRT20112013

SVK20112013

SVN20102013

ESP20102013

C. Change in the labour tax wedge3

For a single person with no children at different earning levels, percentage points

67% of average earnings 100% of average earnings 167% of average earnings



ratio to GDP (3% and 60%, respectively). The preventive arm is based on the so-called

medium-term objective (MTO), which provides a medium-term target for the structural

budget balance of each country.

Some 2011-13 reforms make better allowance for the fiscal and economic situation of

the EU member states. At the same time, SGP rules have become complex due to the

proliferation of different numerical targets, procedures, contingency provisions and

compliance indicators across the two arms (OECD, 2014a; Eyraud and Wu, 2015). The SGP

has nonetheless remained primarily focussed on individual national policies, with scope

for further consideration of their aggregate area-wide impacts. Furthermore, despite

strengthened enforcement provisions of the preventive arm, those of the EDP remain more

visible, often making policymakers focus on the 3% of GDP deficit threshold, risking

procyclical policy responses. With Treaty changes unlikely in the coming years (Juncker

et al., 2015; European Commission, 2015d), the short-term challenge is to ensure a sound

application of the current SGP rules. In particular, degrees of freedom afforded by the rules

should be used by countries with fiscal space to contribute to a more supportive joint euro

area fiscal stance.

The preventive arm contains some welcome flexibility in the structural balance

trajectory towards the MTO. The required annual fiscal adjustment depends on cyclical

conditions (for instance, with no required adjustment in case of negative GDP growth). In

some cases, there can be temporary deviations from the MTO or the consolidation plan

towards it to accommodate the short-term fiscal costs of major structural reforms,

including certain kinds of investment. Rule enforcement allows for some margins of

tolerance, since a deviation from the MTO or the path towards it is regarded as significant

only if it reaches at least 0.5% of GDP in one year, or 0.25% on average in two consecutive

years. Further, countries may be allowed to temporarily deviate from the adjustment path

towards the MTO in periods of severe area-wide economic downturn, a provision unused

so far.

As cyclical conditions improve and more countries leave the EDP, the need for fiscal

adjustment under the preventive arm will increase. In this context, rules should be strictly

enforced to help avoid a return to fiscal slippages in good times, as occurred before the

global financial crisis (Eyraud and Wu, 2015; Carnot and Castro, 2015). In bad times,

national fiscal policies should take account of cross-country spillovers (Goujard, 2013) and,

within SGP rules, contribute to supporting euro area aggregate demand. In the current

weak recovery, countries should use the flexibility afforded by preventive arm rules to

temporarily slow down or halt consolidation efforts and, if room for manoeuvre under the

SGP exists, adopt a temporary fiscal expansion. Public investment on trans-European

networks should rank high among the priorities for using fiscal space. The recently

announced European Fiscal Board may help to inform the debate on the appropriate

area-wide fiscal stance and how it should translate into national fiscal stances.

In the corrective arm, large adjustments induced by the debt reduction benchmark

should be avoided. The benchmark requires that the excess of the debt ratio over 60% of

GDP be reduced at an average 1/20th per year (with some transitional provisions). For

highly indebted countries, these fiscal adjustments can be very large. Italy, for instance,

would have needed a cumulative structural effort of around 3 per cent of GDP over 2013-15

(European Commission, 2015e). In the cases it has examined so far (Belgium and Italy), the

Commission took account of expected compliance with preventive arm requirements and



expected implementation of ambitious structural reforms, as well as of unfavourable

economic conditions (especially low inflation), and decided not to open an EDP

(European Commission, 2015e, 2015f). A similar approach should be taken in forthcoming

cases, as other highly indebted countries leave the EDP and become subject to the debt

reduction benchmark. In a future SGP revision, the appropriate speed of adjustment

towards the 60% of GDP debt threshold should be reviewed (see below).

It is also important to strengthen incentives for reform, including of national budget

frameworks. The corrective arm requires an annual adjustment of at least 0.5% of GDP

regardless of cyclical developments, which may imply a procyclical stance, and a deadline

for eliminating the excessive deficit. Longer deadlines are the main provisions for

flexibility. Largely due to the recession, only five euro area countries achieved compliance

with the initial deadline in EDPs that started in 2009/10, and five others were granted two

or more deadline extensions. Building on recent steps (European Commission, 2015g), the

Commission could make greater use of longer initial deadlines (or deadline extensions,

conditional on a satisfactory track record of fiscal adjustment) to provide incentives for

fiscal-structural reforms. Greater emphasis should also be given to the quality of national

budgetary frameworks (an aspect already contemplated in current legislation) when taking

EDP steps.

Over the medium term, SGP rules should be improved along two main dimensions.

First, to reduce complexity and asymmetries in enforcement, the preventive and corrective

arms could be more closely aligned and possibly merged, giving rise to a single set of

targets, procedures and indicators. Second, the current multiplicity of numerical rules

could be replaced by a single fiscal anchor underpinned by a single operational rule (Andrle

et al., 2015). The natural anchor is the public debt-to-GDP ratio in each country, given its

direct link to fiscal sustainability. These reforms would imply very substantial legislative

changes, including to the Treaty. The spring 2017 White Paper envisaged in the Five

Presidents’ Report (Juncker et al., 2015) offers an opportunity to start preparatory work.

Reinforcing national budgetary frameworks

Budget frameworks at national level play a key role in improving the quality of public

finances and the procedures and institutions involved in preparing, approving and

executing budgets are highly country-specific. The SGP reform of 2011-13 required stronger

national fiscal frameworks, including numerical fiscal rules, independent fiscal

institutions and improved budget reporting and transparency. Important strides have been

made in some areas, such as the coverage and timeliness of budget statistics and the

creation of independent fiscal institutions. However, overall budget reform activity since

late 2011, as assessed by the OECD, has been generally modest (Figure 22). Apart from the

transposition of the MTO into national law, the adoption of national-level numerical rules,

such as expenditure rules with a broad coverage, has been limited (Schaechter et al., 2012;

Bova et al., 2015). In most countries, more micro-level reforms enabling systematic

expenditure prioritisation or the efficient use of performance information in budgeting

have also had low implementation.

Adopting national expenditure rules and regularly conducting spending reviews

would upgrade budget frameworks in mutually reinforcing ways. Expenditure rules offer a

good balance between sustainability and stabilisation objectives, as automatic stabilisers

are largely on the revenue side, and tend to perform well on other counts, such as

simplicity and ease of communication (Andrle et al., 2015). In turn, through systematic



scrutiny of baseline expenditure, spending reviews can improve prioritisation and help

achieve efficiency gains (Robinson, 2014). Rule-based aggregate expenditure ceilings

provide a medium-term anchor to the determination of annual spending allocations, and

thus facilitate reforms to increase the efficiency of public spending at sectoral or

programme level. When integrated into the regular process of budget preparation,

spending reviews support adherence to aggregate spending ceilings. Monitoring of rule

compliance, as well as of spending reviews’ follow-up recommendations and respective

impacts, should be entrusted to an independent fiscal institution.

Besides monitoring compliance with fiscal rules and preparing or endorsing

macroeconomic forecasts, according to SGP requirements, the remit of national independent

fiscal institutions could be usefully extended to estimating the costs of proposed policies, a

common task among such institutions outside the European Union (Debrun and Kinda,

2014). This would contribute to a more informed public debate on spending and tax policies,

potentially leading to a better design of such policies. Independent fiscal institutions should

also be provided with the resources and conditions for a credible fulfilment of their mandate.

Staff needs would generally increase if institutions were tasked with cost estimates, as

this requires sector and programme-specific expertise. Safeguards on institutions’ budgets,

such as multiannual funding commitments, are often lacking, but would enhance the

independence of those bodies (OECD, 2014b). Less than half of EU independent fiscal

institutions have full access to non-public budgetary information (European Commission,

2014). Finally, relations between the new advisory European Fiscal Board and national

independent fiscal institutions should be organised in a mutually-reinforcing way, as

planned, thus avoiding to undermine the scope of action and credibility of the latter.

Figure 22. Intensity of budgetary reform in euro area countries1

Since end 2011, number of countries

1. The degree of budget reform intensity is based on a qualitative assessment, by reference to the principles set out in the OECD“Recommendation of the Council on Budgetary Governance” (18 February 2015) of answers provided by 28 OECD countries to aquestionnaire on changes to institutional budgeting frameworks since the end of 2011. Reforms relating primarily to fiscal rules,independent fiscal institutions and parliamentary/civic participation have been discounted relative to those in other areas. Draftassessments were submitted to the Working Party of Senior Budget Officials for discussion in June 2015.

2. Intensive reform activity and/or broadly-based across various aspects of budgetary governance.3. Moderate reform activity and/or focused on specific aspects of budgetary governance.Source: OECD (2015), The State of Public Finances 2015: Strategies for Budgetary Consolidation and Reform in OECD Countries.

1 2 http://dx.doi.org/10.1787/888933367092

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1

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Intensive² Moderate³ Not significant



Leveraging the impact of EU investment policies

Both European and national policy levers play a key role in ensuring enough and

efficient spending on public investment. EU budget funds for investment and other

growth-enhancing expenditure, such as on education and active labour market

programmes, stand at 0.5% of EU GDP. This amount is arguably too low if account is taken

of the potential for generating economies of scale and positive externalities, for example

from research and development or infrastructure. However, even these limited resources

can have a leveraged impact on the composition and efficiency of public finances if

deployed in a way to crowd in national public funds and private investment, and foster

greater investment productivity. At national level, better co-ordination of investment

across levels of government and upgraded administrative capacity would increase

investment efficiency.

The structure of EU budget expenditure should be made more growth-friendly. Funds

aimed at investment and growth account for close to half of the total (Figure 23, “Smart and

inclusive growth”). Most of these resources fund European regional policy and are

geographically allocated. In contrast, “Competitiveness for growth and jobs” programmes are

directly managed at European level with no country-specific allocations. They include,

among others, the research and innovation Horizon 2020 and the Connecting Europe Facility

(targeted at the development of trans-European networks in transport, energy and digital

services). Also, in the context of the Investment Plan for Europe, the European Fund for

Strategic Investments supports projects across the EU with no geographic pre-allocation. In

the short term, it is essential to preserve investment and growth allocations in the face of

pressures on other fronts, such as the refugee crisis. In the longer term, post-2020 financial

frameworks should continue to increase resources for growth-enhancing expenditure,

funded by either reallocation of expenditure or an increase in the overall EU budget size.

Figure 23. European Union budget: Structure of expenditureAs a percentage of total commitments appropriations for 2014-20

1. CAP: Common Agricultural Policy.Source: European Commission (2014), European Union: Public Finance, 5th Edition.

1 2 http://dx.doi.org/10.1787/888933367109

0 5 10 15 20 25 30 35

Security and citizenship

Global Europe

Administration

Other sustainable growth expenditure

Market-related expenditure and direct payments

Competitiveness for growth and jobs

Economic, social and territorial cohesionSmart and inclusive

growth

Sustainable growth

(mainly CAP)¹



It is important to ensure additionality in EU regional policy (i.e. that EU funding adds

to, rather than replaces, national public spending) and that funds are spent efficiently.

Monitoring and enforcement mechanisms for additionality have been reinforced only

gradually, and remain weak: possible sanctions appear late in the process (not before 2022

for the 2014-20 period) and are relatively light. Furthermore, especially for euro area

countries, the levels of gross fixed capital formation required for compliance with

additionality look often unambitious, implying an increase in the share of European

structural and investment funds (and thus a decrease in that of national funds) in total

public investment (Figure 24). Current rules for additionality should be credibly enforced,

starting with the 2018 mid-term verification, where increasing required investment levels

could be considered. In future programming periods, more ambitious levels should

likewise be envisaged, and possible sanctions brought to an earlier stage.

To support institutional quality and investment efficiency, conditionality

requirements in EU regional policy have been generally reinforced in the 2014-20 period.

Numerous ex ante conditionalities need to be met before the disbursement of funds, either

of a general nature (such as compliance with public procurement rules) or of a thematic

one (such as the existence of national strategies in specific sectors). In addition,

macroeconomic conditionality aims to reinforce consistency between European structural

and investment funding and key elements of EU economic governance. For instance, to

better address country-specific recommendations, the Commission may request countries

Figure 24. European structural and investment funds as a share of public investment1

Per cent

1. Allocations for the European Regional Development Fund, European Social Fund and Cohesion Fund as a share of government grossfixed capital formation.

2. Share of European structural and investment fund (ESIF) allocations in public investment if the latter equals the agreed referencelevels for additionality verification. The fact that part of ESIF allocations will not fund gross fixed capital formation but rather otherspending items (e.g. certain transfers) helps explain why shares can exceed 100%. In Italy and Slovenia the national-wideadditionality targets depicted are merely indicative, as additionality will be verified at a regional level.

Source: Calculations based on allocation data from European Commission Decision documents C(2006) 3473, 3474, 3475 and lateramendments, C(2014) 2082 final and “Available budget 2014-2020”, http://ec.europa.eu/regional_policy/en/funding/available-budget; grossfixed capital formation data from OECD (2015), OECD Economic Outlook: Statistics and Projections (database) and Long-term Baseline, internaldatabase, Economics Department.

1 2 http://dx.doi.org/10.1787/888933367118

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CZE EST GRC HUN ITA POL PRT SVN ESP SVK

2008-10 2011-13 2014-16 Additionality target²



to reprogramme structural and investment funds, which could improve their alignment

with relevant structural reforms. As in the case of ex ante conditionalities, preserving

national ownership of reforms and other requirements will nonetheless be key.

In other cases, however, macroeconomic conditionality may be counterproductive. For

example, the Commission must propose a suspension of structural funds when the

Council assesses that no effective action has been taken to correct an excessive deficit.

Though modulated in the light of economic and social conditions, suspended amounts will

be at least in the range of 0.25 to 0.5% of GDP (or 25% to 50% of annual structural and

investment funding if lower). This suspension will be lifted and re-budgeted as soon as the

member state has adopted the necessary corrective action. Nevertheless, under fiscal

stress, these sanctions would likely worsen the composition of public expenditure by

intensifying downward pressures on public investment and other growth-enhancing

items, and should therefore in most cases be avoided.

Announced in November 2014, the Investment Plan for Europe aims to generate at

least EUR 315 billion (2.2% of 2015 EU GDP) of additional investment over three years,

mainly from private sources and with a focus on strategic sectors, including infrastructure,

innovation and SMEs. The Plan’s funding pillar (the European Fund for Strategic

Investments, EFSI) allows the European Investment Bank (EIB) Group to finance projects

that would not have been supported otherwise. The EFSI is endowed with a risk-absorbing

capacity of EUR 21 billion: EUR 5 billion from EIB resources, and an EU guarantee of

EUR 16 billion. This guarantee will be backed up by EU budget resources mainly reallocated

from other growth-enhancing programmes (Horizon 2020 and the Connecting Europe

Facility). Alternative reallocations, drawing on less growth-friendly expenditure, would

have been preferable. Similarly, it is important to ensure that the amounts committed by

several countries to provide co-financing to investments represent additional public

support, rather than investment reallocation. EFSI-supported investment has so far

provided negligible stimulus to activity, but it may have a positive medium-term impact:

project approvals are proceeding in line with the target, with those approved by

mid-May 2016 expected to trigger total investment of about EUR 100 billion in the coming

years. The Plan also comprises a second pillar for technical assistance (through the

European Investment Advisory Hub) and project promotion, and a third pillar for structural

reforms to create an investment-friendly environment, which are discussed in the 2016

OECD Economic Survey of the European Union. A case in point, essential to unlock

investment, is the reduction of regulatory heterogeneity across Europe.

Given limited public resources, the medium-term success of the Plan will hinge on its

ability to leverage private investment, for which the EIB Group’s lending behaviour and the

quality of the projects presented will be key. The EUR 315 billion investment target

presupposes a multiplier of 15: the EFSI guarantee should enable three times as much EIB

Group funding, which will be used to finance an average 20% of the value of investment

projects (the remainder coming from additional investors, with a large role played by

the private sector). This requires selecting projects which are attractive for additional

co-funding and (to avoid crowding-out) which would not otherwise be carried out.

Crowding in private investment on the scale envisaged also requires that the EIB Group

depart from its usual very prudent lending practices, characterised by a choice of low-risk

projects and negligible levels of non-performing loans (Claeys, 2015). This implies

accepting projects with higher risk than in the past, and financing on average a lower share

of each (one-fifth, rather than the traditional one-third to one-half).



Improving public investment governance

At national level, stepping up efforts to co-ordinate investment among tiers of

government is essential. Across the OECD, sub-national governments account for about

60% of total public investment, highlighting the need for vertical and horizontal

co-ordination mechanisms (OECD, 2013). However, effective co-ordination is difficult: in a

recent survey on infrastructure investment, more than three quarters of EU sub-national

governments reported co-ordination challenges (OECD and Committee of Regions, 2015).

Potential tools to foster co-ordination include bringing together different jurisdictions in

dialogue fora with actual involvement in decision-making, co-financing and conditionality

mechanisms, and the promotion of collaboration between sub-national governments

through the removal of legal and regulatory barriers, possibly coupled with financial

incentives. Better co-ordination among sub-national governments will also enhance their

ability to promote sound investment projects under the Investment Plan for Europe.

Public administration capacity is also essential for efficient investment, but is often

inadequate, especially at sub-national level. There is wide variation in the perceived

quality of sub-national governments across the European Union, as well as within some

countries (Charron et al., 2012). Capacity challenges have been identified at various stages

of the investment cycle, including long-term strategic planning, the ability to involve the

private sector (for instance through public-private partnerships) and public procurement

(OECD, 2013). Aware of these weaknesses, EU regional policy has included the

enhancement of administrative capacity among its ex ante conditionalities for the 2014-20

period, with an accompanying increase in financial support for this purpose. A recent

proposal for a Structural Reform Support Programme (European Commission, 2015h) will

also support capacity building, namely through technical assistance. At the same time, the

European Investment Advisory Hub has the potential to provide expertise to national

authorities and co-ordinate the already existing technical assistance activities. National

authorities should prioritise actions to preserve and develop administrative capacity at

different levels of government in response to the main gaps detected. In times of fiscal

restraint, these considerations should inform the design of fiscal consolidation.

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ANNEX. PROGRESS IN STRUCTURAL REFORM


Main recommendations Action taken since the previous Survey (2014)

A. Monetary policy

Keep the current expansionary monetary policy stance over anextended period, subject to the outlook for price developments over themedium term.

Monetary policy has become more supportive since mid-2014, throughpolicy rate cuts (which have taken the deposit rate increasingly tonegative territory), a series of targeted long-term refinancingoperations and expanded asset purchases.

B. Banking regulation and banking union

Ensure that the ongoing comprehensive assessment of banks – whichconsists of three complementary elements: a supervisory riskassessment, an asset quality review and a stress test – leads to aconsistent overall evaluation of banks’ balance sheets.

The 2014 comprehensive assessment of banks’ balance sheetsimproved information on the health of the financial sector and led, in anumber of cases, to bank recapitalisations, paving the way for thecoming into operation of the Single Supervisory Mechanism.

Adopt a single resolution mechanism with predictable and swiftdecision-making that is politically accountable, and ensure that it isoperative soon after the Single Supervisory Mechanism is in place. Theagreement needs to ensure the effectiveness of the mechanism and itsability to quickly take decisions in emergency situations.

The Single Resolution Mechanism became fully operational inJanuary 2016. Its ability to take decisions in emergency situations hasnot been tested yet.

Ensure legal certainty and equal treatment in the bail-in of bankcreditors across states to avoid complicating resolution processes anda potential negative impact on bank funding. Ensure minimisation ofnational discretion in setting resolution conditions.

The Bank Recovery and Resolution Directive was adopted (May 2014)and has been transposed by most countries. However, transpositionhas had some delays and has resulted in substantial heterogeneityacross countries in resolution settings.

For the national resolution funds to be set up under the Bank Recoveryand Resolution Directive, ensure that burden-sharing arrangementsfor banks with cross-border activities are available. For theSingle Resolution Fund, establish strong arrangements to ensurecross-border resolution financing as long as the resources of thenational compartments of the Fund are not yet fully pooled. Move overtime to full pooling of the Fund resources. Prefund the Resolution Fundor temporarily bridge funding gaps that might occur in the transitionphase via a fiscal backstop and recuperate the finances needed byrisk-based contributions from the banking sector.

As per an intergovernmental agreement (May 2014), the SingleResolution Fund will be built-up over 2016-23 with risk-adjustedcontributions from banks, and its national compartments will begradually mutualised. In December 2015 countries agreed to set upnational credit lines backing the respective national compartments.

Complement the Resolution Fund by a common fiscal backstop that isfiscally neutral over the medium term and recoups ex post any bridgefinancing via contributions from the financial sector.

No action taken.

Possible changes in the treatment of sovereign bonds, notably thegradual phasing out in the long run of the zero-risk weighting, shouldbe assessed with a specific attention to possible impacts on thestability of financial markets. Any decision would need to be taken in aco-ordinated manner at the international level. Diversify in the long runthe banks’ exposure to the debt of a single sovereign. Assess the meritsof leverage ratios, as a supplementary measure to risk-weighted ratios,for gauging the strength of bank balance sheets.

Preparatory work on different policy options for reforming theregulatory treatment of sovereign exposures has continued. Nodecisions have been taken yet.

C. Fiscal policy and the budgetary framework

Continue fiscal consolidation, respecting the requirements of theStability and Growth Pact, as planned and allow the automaticstabilisers to operate fully.

The aggregate fiscal stance turned into broadly neutral in 2015 and isexpected to remain so in 2016, which is welcome, as it eliminated asource of drag on domestic demand.

Design fiscal consolidation to favour inclusive growth and employment. In most cases, fiscal consolidation strategies have not favouredgrowth, equity and employment. Public investment has not recoveredfrom previous cuts. Though some countries reduced socialcontributions in 2015, this has only reversed a small part of previousincreases in labour taxation.

Ensure effective implementation of the strengthened EU and FiscalCompact rules in national fiscal frameworks, including medium-termbudgeting, identification of future spending and revenue pressures andrisks, independent fiscal councils and effective mechanisms to correctdeviations from fiscal targets.

More countries have set up independent fiscal institutions andtransposed the medium-term objective and the adjustment pathtowards it into national law. The coverage and timeliness of budgetstatistics have improved. Less progress has been made in adoptingnational expenditure rules and regularly conducting spending reviews.