Euro area is recovering strongly, but challenges lie
Economic policies in the euro area have forcefully supported household incomes and protected corporate balance sheets. High levels of vaccination and increasing adaptation to the pandemic have also helped to foster a strong economic recovery.
The challenge now is to coordinate the normalization of economic policy in the face of elevated uncertainty, including the evolution and legacies of the pandemic, as well as ongoing geopolitical tensions. Agility will be key, as policies become increasingly targeted to contain scarring and mitigate a potential rise in inequality and poverty.
Once the expansion is firmly underway, highly indebted countries in particular will need to reduce their debts. Credible plans to achieve this should be announced now. In addition, European Union fiscal rules need reform, including consideration of an EU-level climate fund.
Under the baseline, medium-term inflation dynamics are expected to remain weak. But upside inflation risks have clearly increased, and the European Central Bank should stand ready to adjust course as needed.
Some euro area countries could tighten their macroprudential stance given stretched asset valuations, especially in real estate markets.
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The labor market recovered rapidly but unevenly across sectors. Policies need to facilitate labor reallocation and protect the vulnerable, which includes reskilling and upskilling workers, using hiring subsidies, and enhancing targeted safety nets.
Structural reforms and high-impact investment envisioned in the Next Generation European Union package are crucial to enhance resilience, support green and digital transitions, and boost potential growth.
