Recommendation for a

COUNCIL RECOMMENDATION

on the economic policy of the euro area

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty on the Functioning of the European Union, and in particular Article 136(1) in conjunction with Article 121(2) thereof,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies, and in particular Article 5(2) thereof,

Having regard to Regulation (EU) No 1176/2011 of the European Parliament and of the Council of 16 November 2011 on the prevention and correction of macroeconomic imbalances, and in particular Article 6(1) thereof,

Having regard to the recommendation of the European Commission,

Having regard to the conclusions of the European Council,

After consulting the Economic and Financial Committee,

After consulting the Economic Policy Committee,

Whereas:

(1)The euro area’s post-COVID economic recovery has been interrupted by a series of external shocks. Thanks, in particular, to decisive economic policy response, both at national and EU level, and to the lifting of containment measures, the euro area posted solid GDP growth in 2021 and 2022, 5.3 % and 3.2 % respectively. Labour market also proved resilient, with the unemployment rate set to reach the record low rate of 6.8 % in 2022. However, the increase in global energy prices, heightened uncertainty and supply chain disruptions induced by Russia’s war of aggression against Ukraine resulted in a clear deceleration in economic activity in the second half of 2022, and the energy crisis has led to a downward reassessment of forecasts for 2023. Overall, GDP growth in the euro area is set to decrease to only 0.3 % in 2023 before returning to a 1.5 % growth in 2024. The energy market and other commodities markets have been fuelling inflation, which over time has broadened into other items and reaches 8.5 % in 2022. Inflation is now expected to remain elevated in the coming months, staying at 6.1 % in 2023 before easing in 2024. Labour markets are expected to remain robust as demand for labour remains high. With a large share of businesses still reporting labour shortages, unemployment is set to increase only moderately next year, before abating again in 2024. Meanwhile, nominal wage growth is expected to increase in 2023 but to remain below inflation, leading to a drop in purchasing power of households. In this context, the euro area’s current account surplus has receded, in line with the strongly deteriorating energy balance and, going forward, the nominal depreciation of the euro against the US dollar and some other currencies since the second half of 2021 is likely to provide only a modest boost to competitiveness given the high energy costs.

(2)The deterioration in macroeconomic conditions and large price differentials across Member States challenge income and business cycle convergence in the euro area. While the COVID-19 pandemic led to deep, though largely transitory, divergences in macroeconomic performance, it had a limited and temporary impact on business cycle synchronisation. The energy crisis brings with it new heterogeneous macroeconomic impacts in the euro area. Due to cross-country discrepancies in energy mixes and in policies to mitigate the impact of the energy shock, large differences in headline and core inflation rates have emerged across the euro area. Higher energy prices and supply chain pressures have had an uneven impact on manufacturing and services across euro area Member States and may result in drifting relative competitiveness. While available indicators suggest that competitiveness gaps within the euro area have been limited so far, divergences in current account balances in the euro area have recently widened mainly on the back of deteriorating energy balances.

(3)Ensuring an appropriate policy response to a deteriorating economic outlook and high inflation is a requires monetary and fiscal policies to be appropriately calibrated and coherent. Monetary policy normalisation has to address high and divergent inflation while tackling possible risks of unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area. In the current climate, a broad-based fiscal expansion to support demand would further fuel inflationary pressure, at a time when public debt is elevated in several euro area Member States. This calls for fiscal policies that are appropriately differentiated across Member States according to the economic and fiscal situation, as recommended by the Council in July 2022. It also requires them to be prepared to adjust current spending to the evolving situation. At the same time, targeted and temporary fiscal measures are needed to support vulnerable people and companies, also with a view to maintaining jobs and human capital, while preserving price signals and providing incentives to reduce energy consumption. Close coordination of policy responses between Member States remains crucial. Labour market and social policies are also instrumental in addressing the social impacts of high inflation. Average wages are not keeping up with inflation in 2022. Going forward, wage developments need careful balancing to protect wage earners’ purchasing power – with a focus on low-wage earners – while avoiding the risk that wages feed inflation and deepen emerging competitiveness differentials within the euro area and worldwide. Active involvement of social partners helps identify challenges, including on the specific challenges for the monetary union, improves policy solutions, and ensures broader ownership of the economic and social policy agenda. Supply-side policies can also contribute to lower inflation by accelerating the build-up of alternative energy supplies, enhancing competition, improving the allocation of resources, and supporting productivity growth. Risks to financial stability also require continued monitoring.

(4)The Recovery and Resilience Facility (RRF) and cohesion policy funds are key tools to strengthen the resilience of the euro area and support convergence. The implementation of the RRF in the euro area Member States is well on track, with over EUR 128 billion paid in pre-financing and following the fulfilment of milestones and targets. Since the outbreak of the pandemic, cohesion policy programmes disbursed over EUR 82 billion to euro area Member States. The RRF and cohesion policy funds contribute to the euro area policy priorities through several channels: both support economic activity through additional investment and, in the longer term, the planned investments and structural reforms are set to support the green and digital transition while stimulating higher growth in productivity and potential output. A large proportion of investments and reforms carried out as part of the RRF is relevant for the implementation of euro area policy priorities identified in previous euro area recommendations. Accordingly, continuing to implement planned reforms and investments based on the planned schedule is essential to maintain the reform momentum.

(5)To ensure a consistent economic policy response at the EU level, the Annual Sustainable Growth Survey (ASGS) outlines the key policy priorities and guidelines for the year ahead. The ASGS is in line with the UN Sustainable Development Goals and is structured around the four dimensions of competitive sustainability: environmental sustainability, fairness, productivity, and macroeconomic stability. The Alert Mechanism Report provides the Commission’s analysis of potential macroeconomic imbalances that may hinder the proper functioning of Member State economies, the Economic and Monetary Union and the Union as a whole.

(6)The rapid increase in inflation over the past year has prompted a rapid adjustment of the monetary policy stance worldwide. The European Central Bank (ECB) has started normalising monetary policy to ensure a timely return of inflation to the 2% medium-term target. It has also indicated that the normalisation of interest rates will continue, taking into account economic data developments. Supply constraints play a significant part in the recent inflation surge, and inflation differentials make the conduct of monetary policy more challenging. An even transmission of the policy stance across the euro area is a precondition for monetary policy to deliver on its mandate.

(7)The euro area fiscal stance, measured as the change in net primary expenditures relative to average potential growth, is projected to be expansionary in 2022 and broadly neutral in 2023, conditional on the planned roll-back of energy-related measures. In 2023, fiscal policy should avoid amplifying the inflationary effects of the ongoing supply shocks and, both at national level and for the euro area as a whole, a broad-based fiscal impulse to the economy is not warranted. The challenge is particularly acute for Member States experiencing high core inflation, also in light of the serious economic and social difficulties inflicted by the erosion of wage earners’ purchasing power, in particular for low wage earners. Moreover, fiscal policy should remain prudent and combine higher investment with controlling the growth in net primary current expenditure. In this context, the expected further increase in RRF absorption and in nationally-financed investments across Member States are consistent with the need to expand public investment for the green and digital transition and for energy security. At the same time, the fiscal policy agility would help to respond to high uncertainty and strong downside risks to the economic outlook, while not undermining incentives for the energy transition. The COVID-19 pandemic has left a legacy of record-high debt in the euro area, and public debt is expected to remain much higher than pre-pandemic levels in most euro area Member States. While short-term sustainability risks have largely decreased, medium- and longer-term risks remain elevated in several Member States, and interest rates rises will eventually feed into higher debt burden.