COMMISSION STAFF WORKING DOCUMENT Analysis of the euro area economy Accompanying the document Recommendation for a COUNCIL RECOMMENDATION on the economic policy of the euro area
Date: 2020-11-18
Institutions: Directorate-General for Economic and Financial Affairs, European Commission
Subjects: EU banking union, coronavirus disease, economic growth, economic reform, epidemic, euro area, fiscal policy, labour market, structural adjustment, sustainable development

EN 

  EN 

   EUROPEAN COMMISSION  Brussels, 18.11.2020  SWD(2020) 276 final  COMMISSION STAFF WORKING DOCUMENT Analysis of the euro area economy Accompanying the document Recommendation for a COUNCIL RECOMMENDATION on the economic policy of the euro area {COM(2020) 746 final}  
 
 
Contents 

1.  Macro-economic outlook and the risk of divergences ........................................................ 6 

1.1. Macroeconomic context and developments .................................................................... 6 

1.2. COVID-19 and the risk of divergence .......................................................................... 10 

1.3. Long-term impact of the COVID-19 on productivity growth ...................................... 13 

2.  The macroeconomic policy stance ................................................................................... 16 

2.1 The fiscal policy stance .................................................................................................. 17 

2.2 Expenditure Policy ......................................................................................................... 21 

2.3 Revenue Policy .............................................................................................................. 23 

3.  Structural issues and reform developments ...................................................................... 25 

3.1. Single market integration .............................................................................................. 27 

3.2. Labour markets and social protection ........................................................................... 29 

3.3. Labour market skills for the digital and green transitions ............................................ 31 

3.4. Insolvency frameworks ................................................................................................. 32 

3.5. Administrative and absorption capacity and other drivers of institutional quality ....... 34 

3.6. Risks of macroeconomic imbalances ............................................................................ 36 

4.  Macro-financial Stability .................................................................................................. 38 

4.1. Financial market developments .................................................................................... 38 

4.2. Risks to macro-financial stability ................................................................................. 41 

5.  The EU recovery plan: its impact on EMU and the international role of the euro ........... 42 

5.1. Impact of the European recovery plan on the international role of the euro ................ 42 

5.2. Remaining missing elements of the EMU architecture ................................................ 45 

1 

 
 
 
 
 
 
Executive summary 

Following  the  COVID-19  shock,  the  euro  area  economy  entered  a  sudden  and  deep 
recession  in  the  first  half  of  this  year  and  remains  vulnerable  to  the  persisting  health 
crisis.  Unprecedented  policy  measures  are  expected  to  mitigate  significantly  the  immediate 
impact of the shock, but the uncertainty surrounding the outlook will remain particularly high 
as long as the pandemic hangs over the economy. Risks remain exceptionally large. Thanks 
to short-time work schemes, combined with a drop in total hours worked and in activity rates, 
the unemployment rate is estimated to increase only moderately in 2020. The crisis has had a 
bearing on private consumption as social distancing measures translated into forced savings, 
with household savings reaching unprecedented levels. Private sector investment is expected 
to take a severe hit from the crisis. Despite the symmetric nature of the shock, its impact on 
GDP appears to vary significantly across countries with a much stronger negative impact on 
regions  more  dependent  from  contact-intensive  sectors  (e.g.,  tourism,  hospitality  and 
transport).  

The risk of widening economic divergences across euro area countries is increasing and 
can  affect  negatively  the  effectiveness  of  monetary  policy.  Several  factors  could  drive 
divergences within the euro area, which warrant a close monitoring, namely: i) the intensity 
and timing of the COVID-19 shock; ii) the relative size and economic importance of contact 
intensive sectors (e.g., tourism, hospitality and transport); iii) the differences in the resilience 
of the economies, including their adjustment capacity and fiscal space available, which may 
impact  confidence,  investments  and  growth  prospects;  iv)  the  investment  gap    also  in  the 
green and digital sectors; v) pre-existing regional divergences that may be exacerbated; and  
vi)  institutional  differences.  In  addition,  the  functioning  of  product,  services,  labour  and 
capital  markets  are  important  for  the  adjustment  process,  including  addressing  barriers  to 
labour  mobility,  both  geographical  and  across  sectors  and  firms.  Over  the  longer-term,  the 
current  crisis  risks  having  permanent  effects  on  production  factors  and  may  translate  into 
lower growth in labour productivity and incomes, in particular on the back of lower human 
and physical capital.  

Measures  taken  by  Member  States  and  the  European  Union,  together  with  European 
Central  Bank  (ECB)  policy  intervention,  have  taken  aim  at  preventing  bankruptcies 
and  layoffs.  In  order  to  safeguard  medium-term  price  stability,  the  ECB  has  reacted 
forcefully  and  quickly  by  taking  additional  monetary  policy  easing  measures  ensuring  an 
accommodative  monetary  stance.  On  19  March  2020,  the  European  Commission  adopted  a 
temporary framework to use the flexibility under EU state aid rules to support the economy in 
the context of the coronavirus crisis and on 20 March 2020 the Commission concluded that 
the  EU  economy  was  experiencing  a  severe  economic  downturn  and  the  conditions  to 
activate  the  general  escape  clause  of  the  Stability  and  Growth  Pact  were  thus  met,  a 
conclusion endorsed by the ECOFIN Council. In response to the COVID-19 pandemic, and 
as  part  of  a  coordinated  Union  approach,  euro  area  Member  States  introduced  sizeable 
budgetary  measures  to  contain  the  pandemic  and  provide  support  to  individuals  and 
businesses  particularly  affected.  The  fiscal  stance  is  forecast  to  be  highly  expansionary  in 
2020 and to remain supportive in 2021 at both euro area and national level. Overall, the debt 

2 

 
 
sustainability  assessment  of  the  euro  area  leads  to  the  conclusion  that  the  debt  position 
remains sustainable over the medium-term, notwithstanding risks and significant uncertainty.  

Implementation  of  well-designed  structural  policies  will  support  the  recovery,  while 
bringing  the  euro  area  closer  to  the  requirements  of  an  optimum  currency  area  by 
facilitating  the  transmission  of  monetary  policy  and  strengthening  the  resilience  and 
convergence  of  Member  States.  Structural  policies  can  also  contribute  to  make  euro  area 
economies  future-proof,  through  embracing  the  green  and  digital  transition.  New  model 
simulations  provide  further  evidence  that  labour  and  product  market  reforms  could  have 
material growth benefits over the medium term. In general, a number of reform areas appear 
of particular importance.  Insolvency frameworks differ substantially across the EU and this 
divergence  is  an  obstacle  for  cross-border  capital  flows  and  differences  in  proceedings 
contributes to a home bias, as investors shy away from legal risks and costs linked to possible 
restructuring  abroad.  Further  single  market  integration,  especially  in  services,  is  another 
priority  area  for  reforms.  Actions  aimed  at  improving  the  composition  of  national  budgets, 
especially  through  spending  reviews  and  effective  public  procurement  frameworks,  can 
create much-needed fiscal space now, while also help safeguarding fiscal sustainability in the 
long  term.  Labour  markets  and  social  challenges  have  been  aggravated  by  the  COVID-19 
crisis,  with  the  younger  and  some  vulnerable  groups  most  affected,  making  access  to 
inclusive  education  and  training  systems,  effective  active  labour  market  policies,  including 
hiring  incentives,  up-skilling  and  reskilling,  and  enhanced  social  protection  even  more 
relevant.  Gaps  in  the  digitalisation  of  public  administration,  including  justice  systems  and 
public employment services are even more important now.   

Euro  area  banks  entered  the  current  stress  episode  following  a  continuous  risk 
reduction process that resulted in overall higher liquidity and stronger loss-absorption 
capacities than before the onset of the Global Financial Crisis, which in combination with 
various monetary and fiscal policy measures ensured continued credit provision. Nonetheless, 
the crisis could put further pressure on banks’ already low profitability levels. An increase in 
banks’ NPL ratios is likely once government  guarantee schemes, debt moratoria, as well as 
temporary  supervisory  measures  expire.  The  non-bank  financial  sector  experienced  large 
outflows and valuation losses that have been only partly recovered. 

The  support  provided  by  swift  and  sizeable  policy  interventions  has  strengthened 
confidence  and  helped  to  preserve  macro-financial  stability,  but  entails  a  number  of 
trade-offs. To mitigate risks it is crucial to avoid a strong feedback-loop between corporate 
sector  vulnerabilities  and  financial  sector  risks.  For  example,  prolonged  government  loan 
guarantee schemes help protect the banking sector, the non-bank financial sector and ensure 
credit  provision  to  corporates  in  a  context  of  a  protracted  health  crisis,  which  dampens 
prospects  of  a  quick  recovery.  At  the  same  time,  they  could  also  constitute  contingent 
liabilities for Member States’ budgets. Furthermore, in the absence of an effective system that 
distinguishes  viable  from  non-viable  businesses,  prolongation  of  insolvency  moratoria  and 
forbearance of non-performing loans entails difficult decisions as it might make the eventual 
losses under bankruptcy worse, lead to misallocation of funds to non-viable borrowers and in 
turn undermine business confidence ex-ante.  

3 

 
 
Further  work  is  needed  to  improve  upon  the  architecture  of  the  Economic  and 
Monetary Union (EMU). The EU recovery package, with its objective also to strengthen the 
overall  resilience,  has  the  potential  to  impact  the  EMU  beyond  its  short-term  stabilisation 
function  and  its  role  in  supporting  the  recovery  post-crisis.  The  EMU  architecture  remains 
incomplete.  Filling  the  remaining  gaps  could  further  increase  the  euro  area’s  stability  and 
resilience.  Important  elements  are  still  missing,  such  as  a  complete  Banking  Union  and 
Capital  Markets  Union.  While  interrupted  by  the  COVID-19  crisis,  it  will  be  important  to 
continue  the  process  of  assessing  the  effectiveness  of  the  current  economic  governance 
framework. A strong and resilient EMU will also strengthen the international role of the euro 
and  can  ensure  Europe’s  financial  and  economic  autonomy.  By  increasing  the  euro  area’s 
economic  performance  and  resilience  to  future  shocks,  and  by  increasing  issuance  of  high-
quality,  euro-denominated  debt,  the  recovery  package  can  strengthen  the  euro’s  role  as  an 
international  reserve  currency.  The  issuance  of  euro-denominated  debt  could  represent  an 
important step towards further financial markets development and integration in Europe. The 
issuance of green bonds can quicken the pace of the green transition, in areas such as clean 
energy.   

4 

 
 
Introduction 

Following  the COVID-19 pandemic, the euro area entered a sudden and deep recession in 
the  first  half  of  2020.  The  ECB  monetary  policy  interventions,  the  fiscal  policy  and  other 
measures Member States and the European Commission  have taken aim at  protecting jobs, 
preventing  bankruptcies  and  layoffs  and  supporting  the  recovery,  while  at  the  same  time 
strengthening  the  national  health  sectors  to  increase  their  capacity  to  deal  with  the 
pandemic. The European Commission and the Union took unprecedented actions by putting 
in  place  short-term  emergency  measures  including  the  Coronavirus  Response  Investment 
Initiative (CRII) and CRII+ packages and proposing Next Generation EU, a major recovery 
plan which has at its core a new Recovery and Resilience Facility (RRF) as well as adopting 
a  temporary  framework  to  use  the  flexibility  under  EU  state  aid  rules  and  activating  the 
general  escape  clause  of  the  Stability  and  Growth  Pact,  a  conclusion  endorsed  by  the 
ECOFIN Council. In addition, the Union agreed on a number of new instruments to mitigate 
the impact  of  the crisis by providing  a safety net  for  workers  (by funding national  schemes 
through  the  Support  to  mitigate  Unemployment  Risks  in  an  Emergency  -  SURE),  for 
businesses  (through  a  scheme  by  the  European  Investment  Bank)  and  for  Member  States 
including through the European Stability Mechanism’s Pandemic Crisis Support Instrument.  

The  Staff  Working  Document  (SWD)  underpins  the  2021-22  euro  area  recommendation, 
which  provides  further  policy  guidance  on  the  reforms  and  investments  that  euro  area 
Member States should include in their Recovery and Resilience Plans (RRP) and highlights 
areas  where  Member  States  could  work  collectively  to  improve  the  economic  and  social 
resilience of EMU. The SWD offers an analytical assessment of the impact of the COVID-19 
crisis on the euro area and investigates five areas of particular relevance where spill-overs 
and common goods are particularly important: i) risks of further divergence, including in the 
labour  markets;  ii)  the  overall  policy  stance  underpinning  the  recovery;  iii)  the  role  of 
institutional frameworks and structural reforms; iv) risks to macro-financial stability and v) 
completing the EMU and strengthening the international role of the euro. 

Against  the  background  of  a  well-coordinated  and  credible  response  to  the  crisis,  both 
nationally  and  EU  wide,  the  SWD  highlights  several  risks  emanating  from  the  COVID-19 
crisis that, if materialised, could hamper the functioning of the EMU. First, the continuously 
weak  recovery  and  high  level  of  uncertainty  of  the  evolution  of  the  pandemics  suggest  an 
increased  risk  of  divergence  that  can  undermine  the  process  of  economic  and  monetary 
integration.  Second,  the  COVID-19  crisis  risks  further  exacerbating  the  macroeconomic 
imbalances within the euro area and poses new challenges as public and public debt-to-GDP 
ratios  are  on  the  rise.  Third,  despite  some  progress,  structural  factors  hampering  growth 
remain in place in many euro area Member States.  

On  the  positive  side,  the  recent  policy  response  in  the  context  of  the  Next  Generation  EU 
could  bring  the  euro  area  closer  to  the  requirements  of  an  optimum  currency  area  and 
improve the transmission of monetary policy, thereby strengthening the economic resilience 
and  convergence  of  Member  States.  Further  gains  could  also  arise  from  completing  the 
Banking  Union and Capital  Market  Union and from strengthening the international  role of 
the euro, which will be important to ensure Europe’s financial and economic autonomy. 

5 

 
 
1.  Macro-economic outlook and the risk of divergences  

1.1. Macroeconomic context and developments1 

As  a  result  of  the  COVID-19  pandemic,  the  euro  area  economy  entered  a  sudden  and 
deep recession in the first half of this year and it remains vulnerable to the persisting 
health  crisis.  GDP  growth  in  the  euro  area  is  forecast  to  decline  by  7.8%  in  2020  and  to 
rebound by 4.2% in 2021 and by 3.0% in 2022, albeit the recovery is projected to be slower 
than  previously  thought  (Graph  1).  This  sudden  and  deep  output  contraction  halted  the 
expansion  observed in  recent  years and it is expected to  weigh on growth over the forecast 
horizon. Notwithstanding the recovery foreseen in 2021, the level of GDP is expected to be 
about  2.3% lower than before the COVID-19 crisis by 2021Q4 and to  barely  reach  its  pre-
crisis  levels  by  2022Q4  (Graph  1).  The  coronavirus  crisis  translated  into  a  series  of  large 
demand and supply-side shocks that are expected to ultimately generate a large output gap, of 
some  -7.0%  and  -3.8%  of  potential  GDP  in  2020  and  2021  respectively.  Potential  output 
growth is also expected to be significantly lower in 2020 than in the previous five years (and 
well below its pre-crisis average) resulting from a reduced contribution of labour and capital 
accumulation (Graph 2).  

Graph 1: Euro area GDP forecast in Autumn 2019, 
 Spring,  Summer and Autumn 2020 

Graph 2: Contributions to potential growth, in 
the euro area  

Autumn 2019

Spring 2020

Summer 2020

Autumn 2020

105

Dec-2019 =100 

100

95

90

85

80

Dec-19

Jun-20 Dec-20

Jun-21 Dec-21

Jun-22 Dec-22

Source:  Eurostat  and  European  Commission  forecast  (Autumn  2019,  Spring  2020, 
Summer 2020 andAutumn 2020). 

TFP
Capital accumulation
Changes in hours per empl
Labour (persons)
Potential GDP (y-o-y%)

forecast 

%. 

11 12 13 14 15 16 17 18 19 20 21 22

2,0

1,5

1,0

0,5

0,0

-0,5

Note:  The  straight  black  line  corresponds  to  the  pre-crisis  (2002-2007) 
yearly growth. 
Source: European Commission 2020 Autumn Forecast, Ameco. 

Although policy measures are expected to mitigate significantly the immediate impact of 
the shock, downside risks are large. Considerable uncertainty over the length of the health 
crisis still prevails and the initial shock will likely have a longer effect than what had been 
anticipated earlier. On the positive side, the national support schemes that have been put in 
place (see section 3) and the prompt coordinated answer from the EU are expected to support 
the recovery in 2021 and 2022. Other risks predating the crisis, including protectionism risks, 
are still weighing on the outlook. 

1  Based  on  European  Commission.  Directorate  General  for  Economic  and  Financial  Affairs.  “European 
Economic Forecast: Autumn 2020” (Publications Office 2020). 

6 

 
 
 
 
 
 
                                                 
 
Graph 3: Hours worked, total employment and 
activity rates(20-64) in the euro area  

Graph 4: Unemployment rate in the euro area and  
the US (2006-2021) 

Mar-2018 = 100 

Hours worked

Total employment

Activity Rate

103

100

97

94

91

88

85

Mar-18

Dec-18

Sep-19

Jun-20

Source: Eurostat. 

% 

US

EA

16

14

12

10

8

6

4

2

0
2006 2008 2010

Source: Eurostat and FRED. 

2012 2014 2016 2018 2020

The  COVID-19  crisis  is  reversing  the  positive  labour  market  trends  of  the  last  seven 
years  further  exacerbating  unemployment2  and  inequality  trends,  although  policies 
have mitigated part of the negative effects.3 As a consequence of the COVID-19 outbreak, 
the labour market outlook took a turn for the worse. While many jobs were protected through 
the  widespread  use  of  short-time  work  schemes  (supported  by  the European instrument  for 
temporary Support to mitigate Unemployment Risks in an Emergency - SURE4), total hours 
worked have seen a sharp reduction of some 12.8% in Q2 2020 (Graph 3). The activity rate 
(age  group  20-64)  dropped  to  76.4%  in  the  euro  area  in  Q2  2020,  down  by  1.6  percentage 
points  from  the  previous  quarter  driven,  mostly  by  a  fall  in  the  female  activity  rate  (-1.9 
percentage points against -1.5 percentage point of its male counterpart). The widespread use 
of short-time work schemes and the fall in activity rates contributed to a relatively moderate 
increase in unemployment rate, from 7.2% in March 2020 to 8.3% in September 2020, and it 
is expected to remain on the same level in 2020 (on average) and to increase up to 9.4% in 
2021 as the short-time work schemes are expected to  be gradually phased out.  This  is very 
different from the recent experience in the US where the unemployment rate fluctuated much 
more than in the euro area (Graph 4) reaching 14.7% in April (from 3.5% in February).  

2 The unemployment divergence in the euro area is largely due to differences in labour market institutions across 
countries and one of the main drivers of cross-country differences is youth unemployment. Dispersion in youth 
unemployment rates – although decreasing over time – remained high already before the COVID-19 crisis and 
youth unemployment was still above 30% in 2019 in some Member States (Greece: 35.2%; Spain: 32.5%). The 
COVID-19 crisis is likely to exacerbate those differences. See the Joint Employment Report (2020).  
3 Despite the deceleration of economic growth relative to 2018, throughout 2019, the euro area had the highest 
employment in history and the lowest  unemployment level on record. Employment rate  increased up to 68%, 
from 63.5% in 2013, while unemployment rate fell by 4.5 percentage points (between 2013 and 2019), down to 
7.5%  in  2019.  Activity  rates  for  people  aged  20-64  continued  to  rise  in  2019,  reaching  a  record  high  rate  of 
78.6% in the last quarter. 
4  Support  to  mitigate  Unemployment  Risks  in  an  Emergency  (SURE) is a  new  instrument  providing  funding 
solidarity to Member States. SURE can provide financial assistance up to EUR 100 billion in the form of loans 
from the EU to affected Member States to address sudden increases in public expenditure for the preservation of 
employment. The Council has already approved a total of €87.9 billion in financial support to 17 EU Member 
States,  based  on  proposals  from  the  Commission.  The  first  instalments,  worth  €17  billion  overall,  have  been 
disbursed to Italy, Spain and Poland.  On SURE see https://ec.europa.eu/info/business-economy-euro/economic-
and-fiscal-policy-coordination/financial-assistance-eu/funding-mechanisms-and-facilities/sure_en.   

7 

 
 
 
 
  
                                                 
The coronavirus shock is expected to exert downward pressure on inflation and  wages 
in 2020-21. Headline inflation (as measured by the Harmonised Consumer Price Index) in the 
euro  area  is  forecast  to  fall  sharply  to  0.3%  in  2020,  but  to  recover  to  1.1%  in  2021. 
Compared  to  the  winter  forecast,  this  represents  a  downward  revision  of  1.1  percentage 
points in 2020 and 0.3 percentage points in 2021. The combination of weakening economic 
activity  and  a  deteriorating  labour  market  outlook  translates  in  the  near  term  into  lower 
domestic price pressures that also weigh on core inflation (excluding energy and unprocessed 
food  prices),  which  is  forecast  at  0.9%  in  2020  and  1.0%  in  2021.  The  worsening  of  the 
labour market situation is also projected to limit increases in wages and salaries in 2020-21. 
By  the  second  quarter  of  2020,  a  large  majority  of  euro  area  countries  recorded  negative 
changes  in  nominal  wages  (on  a  year  on  year  basis).  Depending  on  the  design  of  national 
short-time  work  schemes,  the  share  of  employees  involved  and  the  intensity  of  the  drop  in 
hours worked, wage decreases varied considerably.5  

Graph 5: Households’ propensity to save  
in the euro area 

Graph 6: Net private and public investment  
in the euro area  

Consumer survey (left-hand scale) 
Saving rate (right-hand scale) 
CEPR recession periods 

ppt 

15

10

5

0

-5

-10

-15

% 

8

7

6

5

4

3

2

1

0

26

24

22

20

18

16

14

12

10

% GDP 

NFC public

NFC Private

Total

1
9
9
9

2
0
0
0

2
0
0
1

2
0
0
2

2
0
0
3

2
0
0
4

2
0
0
5

2
0
0
6

2
0
0
7

2
0
0
8

2
0
0
9

2
0
1
0

2
0
1
1

2
0
1
2

2
0
1
3

2
0
1
4

2
0
1
5

2
0
1
6

2
0
1
7

2
0
1
8

2
0
1
9

2
0
2
0

9
9
9
1

0
0
0
2

1
0
0
2

2
0
0
2

3
0
0
2

4
0
0
2

5
0
0
2

6
0
0
2

7
0
0
2

8
0
0
2

9
0
0
2

0
1
0
2

1
1
0
2

2
1
0
2

3
1
0
2

4
1
0
2

5
1
0
2

6
1
0
2

7
1
0
2

8
1
0
2

9
1
0
2

0
2
0
2

1
2
0
2

2
2
0
2

Note:  Grey  bars  represent  the  recession  periods  as  defined  by  the  Centre  for 
Economic Policy Research. 
Source: ECB. 

Note: Net investment is the difference between gross investment and net of 
consumption of fixed capital (or depreciation).  
Source: Ameco. 

The  crisis  had  a  bearing  on  private  consumption  as  social  distancing  and  other 
restrictive measures translated into loss of income and forced savings (Graph 5). Private 
consumption  in  the  euro  area  fell  sharply  in  March  and  April  as  consumers  lacked  the 
opportunity  or  confidence  to  spend.  This  is  in  stark  contrast  with  the  pre-COVID-19  era, 
whereby private consumption was a strong driver of euro area GDP growth. Notwithstanding 
differences  across  income  levels,  the  overall  unprecedented  savings  by  households  were  a 
key  feature  of  the  consumption  weakness  in  the  first  half  of  the  year.  Already  in  the  first 
quarter  of  2020,  the  household  saving  rate  had  increased  to  16.7%  of  gross  disposable 
income,  reaching  an  all-time  high  of  24.9%  in  the  second  quarter,  up  from  12.6%  in  the 
fourth quarter of last year.6  

5  Particularly  high  decreases,  above  8%,  were  recorded  in  Italy,  Belgium  and  France,  in  terms  of  growth  of 
compensation per employee on annual basis. 
6 Recent ECB research found that more than two-thirds of the additional savings during the first six months of 
2020 constituted “forced savings” — money set aside because people could not spend it. Only a much smaller 

8 

 
 
 
 
 
                                                 
 
Private  sector  investment  is  expected  to  take  a  severe  hit  from  the  crisis.  Gross  fixed 
investment  is  forecast  to  decline  by  around  EUR  1  trillion  in  2020  and  2021  cumulatively 
(compared  to  the  pre-crisis  baseline  given  by  the  Autumn  2019  Forecast)  on  the  back  of 
falling aggregate demand, extreme uncertainty and a severe squeeze on corporate liquidity.7 
In contrast  to  the aftermath  of the Global  Financial Crisis,  the current  crisis  appear to  have 
mainly  affected  private  sector  investment  levels,  with  little  or  no  impact  on  the  expected 
public  sector  investment.  As  savings  persist  and  low  net  private  investments  are  expected 
(Graph  6),  there  is  scope  for  public  investments  to  play  a  larger  role;  indeed  public  sector 
investment has remained broadly unchanged in net terms since 2011.  

Exports of goods and services are likely to remain dampened for some time as demand 
from  outside  the  EU  remains  subdued  and  existing  global  supply  chains  continue  to 
adjust. World trade is forecast to decline by some 10.8% in 2020 and euro area exports by 
11.5%.  As  the  euro  area  is  very  open8  in  comparison  with  other  major  trade  partners,9  the 
COVID-19 crisis is expected to have a major impact on output with the net trade contribution 
to GDP growth expected to fall by 1.1% in 2020, further worsening a -0.5% drag on growth 
in 2019 (in comparison with +0.4 and +0.1 percentage point of contribution to GDP growth 
in  2017  and  2018  respectively).  Besides  the  drop  in  trade  volumes,  the  pandemic  has  also 
altered  the  geography  of  trade  (particularly  of  services),  whereby  a  regional  re-centring 
towards  European  value  chains  has  occurred.  If  this  trend  persists,  while  it  could  reduce 
supply  risks  and  uncertainty,  lower  trade  diversification  could  also  affect  negatively 
economic resilience and productivity. This in turn can have a bearing on convergence given 
the differences in euro area countries’ integration in European and global value chains.10  

The current account of the euro area as a share of GDP has been ebbing since 2017 and 
is  projected  to  further  decline  in  2020.  In  2019,  the  euro  area  current  account  balance  is 
estimated  at  2.3%  of  GDP,  remaining  the  largest  worldwide  in  nominal  terms.11  At 
unchanged policies, the euro area current  account  surplus is expected to  further decrease to 

proportion  was  saved  for  precautionary  reasons  which  are  typically  an  important  factor  in  explaining  the 
increase in household savings during downturns. For more details, see Dossche, M. and Zlatanos, S., “COVID-
19  and  the  increase  in  household  savings:  precautionary  or  forced?”,  Economic  Bulletin,  Issue  6,  ECB, 
September 2020. 
7  For  more  details,  see  “Commission  Staff  Working  Document:  Identifying  Europe's  recovery  needs”,  
accompanying the document “Communication from the Commission to the European Parliament, The European 
Council, the Council, the European Economic and Social Committee and the Committee of Regions: Europe's 
moment: Repair and Prepare for the Next Generation”, SWD(2020) 98 final, 27 May 2020. 
8 Trade openness can make it more difficult to stimulate domestic demand expansion as it spills out through the 
import channel. For  more details, see for instance, Spilimbergo, A., et al., “Fiscal Policy for the  Crisis”, IMF 
Staff Position Note, SPN/08/01, December 2008 and Sutherland, D., et al., “Counter-cyclical Economic Policy”, 
OECD Economics Department WP No. 760, May 2010. 
9  Exports  of  goods  and  services  represented  in  2019  28.5%  of  euro  area  GDP  while  imports  of  goods  and 
services represent 25.2% of euro area GDP. Exports and imports in terms of GDP amount to 11.8% and 14.5% 
in the US, 17.8% and 17.7% in Japan; 18.5 % and 17.4% in China.  
10  For  more  details,  see  Miroudot,  S.,  “Resilience  versus  robustness  in  global  value  chains:  Some  policy 
implications”,  VoxEU.org,  18  June  2020.  doi:  https://voxeu.org/article/resilience-versus-robustness-global-
value-chains.  
11 This surplus continues to mainly reflect the large, but steadily falling, surpluses recorded in Germany and the 
Netherlands, whose combined external balances accounted for 2.7% of euro area GDP in 2019.  

9 

 
 
                                                                                                                                                        
1.8%  of  GDP  in  2020  and  to  edge  up  to  1.9%  of  GDP  in  2021.  While  the  geographical 
breakdown  of  the  current  account  surpluses  are  expected  to  remain  fairly  stable  across 
countries in 2020 and 2021, considerable changes are taking place in the net lending position 
across sectors of the economy, as the large increase in the net lending position for the private 
sector is almost fully offset by a deterioration in that of the government sector.12 

1.2. COVID-19 and the risk of divergence  

The  impact  of  the  COVID-19  crisis  on  GDP  has  depended  on  different  factors, 
including  the  intensity  and  duration  of  the  pandemic  and  has  increased  with  the 
stringency of the containment measures implemented to impede the transmission of the 
COVID-19  virus.  Governments  have  taken  drastic  measures  to  contain  the  spread  of  the 
virus  (e.g.,  lockdown  and  school  closures),  while  voluntary  social  distancing  was  also  an 
important  element  across  euro  area  countries.  These  measures  have  led  to  many  businesses 
being shut down temporarily, widespread restrictions on travel and mobility, financial market 
stress at the onset of the crisis, an erosion of confidence and heightened uncertainty.  

Graph 7: Services production in the euro area 

Graph 8: Share of accommodation and food  
in GDP relative to the fall in 2020 H1 

Total
Air Transport
Restaurants

Retail and wholesale
Accomodations

100

80

60

40

20

0

Jan-20 = 100 

Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20

Source: Eurostat. 

Source: Eurostat. 

By  its  nature,  the  COVID-19  shock  has  had  a  much  stronger  impact  on  services 
activities that require physical interaction and has thus been more detrimental to euro 
area countries where those activities predominate. Most notably, monthly data through to 
July show production in  the restaurant,  hotel, and air transport sectors was hit much harder 
than in other sectors and they were lagging the overall recovery by large margins (Graph 7). 
Euro  area  countries  with  the  largest  shares  of  food  services  and  accommodation  in  their 
economies  have  thus  witnessed  the  steepest  fall  in  GDP  (Graph  8),  and  may  experience 
slower  economic  recovery  and  may  experience  a  slower  economic  recovery.  The  negative 
impact  on  employment  has  been  cushioned  by  short-time  work  schemes  and,  in  some 
countries, restrictions to lay-offs in the first half of 2020. However, these sectors tend to be 
labour-intensive  and more prone to  job  losses,  which is  a threat  for more than one in  three 

12 For more details, see 2021 Alert Mechanism Report (2020). 

10 

 
 
 
 
                                                 
jobs13 in Cyprus, Greece, Spain, Italy and Malta, largely linked to tourism.14 Moreover, some 
durable  goods  sectors  have  also  been  significantly  hit  by  the  crisis,  most  notably  the 
automotive sector15 that was already going through considerable structural changes.  

Graph 9: GDP per capita (PPS) in EU 14 
(expected 2019-21 change  versus actual 2019) 

Graph 10: Net public investment  
in the euro area (2019) 

% GDP 

2,5

2,0

1,5

1,0

0,5

0,0

-0,5

-1,0

-1,5

Note: the straight lines correspond to the EU14 average. (Luxembourg is also 
included in the average, although it is not shown). 
Source: European Commission 2020 Autumn Forecast.   

L
E

T
P

T
I

Y
C

S
E

E
D

E
B

R
F

L
N

T
A

K
S

T
L

I
F

E
I

V
L

I
S

E
E

T
M

U
L

9
1
-
A
E

Note: Net  investment  is the difference between  gross  investment and  net of 
consumption of fixed capital (or depreciation). Net public investment above 
1% of GDP is in green as this level is consistent with a public capital stock 
remaining  at  50%  of  GDP  in  the  euro  area  in  the  short  term  and  gradually 
increasing in the longer term, to take into account the additional investment 
needs related to the Green Deal and the digital transformation. 
Source: European Commission 2020 Autumn Forecast. 

Persistent  macro-economic  divergences  across  euro  area  countries  can  also  affect  the 
effectiveness  of  euro  area  monetary  policy.16  National  institutions  and  the  functioning  of 
labour,  product  and  capital  markets  are  still  very  idiosyncratic,  despite  the  progress  in 
building  the  internal  market.  Moreover,  increased  specialisations  and  agglomeration  effects 
have  been  reinforced  through  economic  integration.  Business  cycles  have  synchronised 
further while their amplitudes have again become more divergent within the euro area.17  

The  COVID-19  crisis  is  increasing  the  risk  of  economic  divergences  across  the  euro 
area. Most notably, GDP per capita level (PPS) in all Member States (excluding Greece) are 

13 The jobs considered fall under the broad sectors “wholesale and retail trade, transport,  accommodation and 
food  service  activities”  and  “arts  and  entertainment”  sectors  (Source:  Eurostat,  National  Account,  Annual 
Employment Data). 
14  Mobility  patterns  have  suffered  a  strong  drawback  in  the  recent  crisis.  The  jobs  considered  fall  under  the 
broad sectors of “wholesale and retail trade, transport, accommodation and food service activities” and “arts and 
entertainment”. See Eurostat, National Account, Annual Employment Data, Nace Rev. 2 Classification.  
15 The personal transport equipment sector accounts for about 42% of durable goods in the euro area. 
16 Real convergence is the cornerstone of EMU resilience. It relates to the idea of narrowing the gaps between 
euro  area  economies  on  a  macroeconomic  level  through  the  long-term  process  of  catching  up.  From  the 
perspective of an efficient monetary policy, convergence of business cycles is a critical factor for a successful 
monetary union. Moreover, another important dimension of convergence is the concept of convergence towards 
resilient economic structures. It implies that euro area economies reduce their vulnerability to shocks, together 
with an increase in their capacity to absorb shocks and in their ability to re-allocate resources. For more details, 
see “Sustainable convergence in the euro area: A multidimensional process”, Quarterly Report on the Euro Area 
(QREA), Vol. 16, No. 3 (2017)/16. 
17 Franks J., B. Barkbu, R. Blavy, W. Oman and H. Schoelermann (2018), “Economic Convergence in the Euro 
Area: Coming Together or Drifting Apart?”, IMF Working Paper No. 18/10. 

11 

 
 
 
 
 
                                                 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
expected to remain well below the 2019 GDP per capita level (PPS) over the next two years 
(Graph  9)  and  Italy,  Spain  and  Portugal  are  forecast  to  fall  by  more  than  the  euro  area 
average. There are several factors that could undermine the process of convergence linked to 
the COVID-19 shock, while jeopardizing the proper functioning and stability of EMU18 and 
ultimately reduce long-term growth prospects. They warrant a close monitoring:  

  The  intensity  and  timing  of  the  initial  shock  and  its  impact  on  movements  of 
workers. To respond to the health crisis, euro area countries have had to implement 
mobility restrictions. As a result, mobility dropped by 45%19 between March and mid-
May  compared  to  pre-pandemic  levels,  contributing  to  the  large  fall  in  GDP  in 
2020H1 (see section 1.1). In addition, barriers to labour mobility, both  geographical 
and across sectors and firms, limit the potential of labour reallocation. Indeed, many 
mobile workers (especially cross-border and seasonal workers) were cut off from their 
place  of  work  or  their  place  of  residence  in  spring.  Currently,  the  situation  has 
stabilised  for  cross-border  and  seasonal  workers,  but  overall  a  strong  decrease  in  a 
new flow for longer-term mobility can be expected in 2020-21. The closure of borders 
within  the  EU  has  highlighted  the  importance  of  intra-EU  labour  mobility  in 
constantly  supporting  the  balance  of  labour  demand  and  supply  and  the  smooth 
functioning of the Single Market. 

  The  relative  size  and  economic  importance  of  contact  intensive  sectors  (e.g. 
tourism  and  hospitality).  Some  more  contact  intensive  sectors  or  ecosystems  will 
take longer to recover even after lockdown measures are relaxed, exposing some euro 
area  economies  more  than  others.  Physical  distancing  requirements  and  associated 
changes in consumer preferences, a lasting shift to remote working and the increasing 
digital  delivery  of  services  would  impact  sectors’  sizes,  change  the  mix  of  jobs 
available and the location of some workplaces. The different sectoral composition of 
Member States’ economies and particularly the proportion of vulnerable occupations 
requiring close contact  with other people, or servicing high contact-intensive sectors 
and  ecosystems,  will  determine  differences  in  the  employment  and  social  impact  of 
the crisis. Most notably, the labour-intensive activities linked to the contact intensive 
sectors are inherently more prone to job losses. Unless the shock proves temporary in 
nature,  adjusting  to  these  changes  is  likely  to  require  substantial  labour  and  capital 
reallocation, and effective active labour market policies, including incentives, to take 
up  jobs  notably  in  green  and  digital  sectors,  re-skilling  and  up-skilling  policies  to 
allow workers to move where there are opportunities. 

  Differences  in fiscal space available, which may impact confidence, investments 
and growth prospects. The depth of the COVID-19 shock required an unprecedented 
fiscal response (see Section 2) and a consequent large deterioration in fiscal positions. 
Countries  with  less  fiscal  space  were  more  constrained  to  provide  stronger  support 

18 On the risk of dampening support for the common currency, see also S.Bergbauer, N. Hernborg, J-F Jamet, E. 
Persson  and  H.  Schölermann  “Citizens’  attitudes  towards  the  ECB,  the  euro  and  Economic  and  Monetary 
Union”, ECB Economic Bulletin, Issue 4/2020. 
19 As measured by the Google Mobility Index. For more details, see Summer (interim) Forecasts 2020. 

12 

 
 
                                                 
during the recovery phase because of the risks of adverse market reactions. The EU 
policy response to the crisis will likely alleviate this by offering large-scale financial 
support  for  investment  and  reforms  and  by  better  preparing  Member  States  for  a 
sustainable  recovery,  and  providing  much-needed  technical  assistance.  Investment 
gap also in the green and digital sectors. The shortfall of investment induced by the 
crisis is set to differ substantially across euro area countries, especially with regards to 
public  investment  (Graph  10).20  Moreover,  Member  States  enter  the  recovery  from 
different starting points with  respect  to  investment  levels  aimed  at  green and digital 
growth.  

  Pre-existent  sub-national  level  differences.  Existent  differences  at  sub-national 
levels  can  further  compound  the  divergence  risks.21  The  regional  impact  of  the 
COVID-19  shock  is  multidimensional.  A  region  more  open  to  trade  may  be  more 
exposed  both  to  the  global  shock  of  COVID-19  and  to  the  disruptions  to  supply 
chains.  Such  regions  comprise  those  with  major  ports  and  other  trade  infrastructure 
and  those  with  relatively  larger  shares  of  employment  in  manufacturing  and  other 
tradable sectors.22  

  Institutional  differences,  including  the  role  of  social  partners.  Differences  in  the 
institutional  set-up affect the capacity to  respond to  shocks. Member States where a 
strong  social  dialogue  culture  prevails  have  shown  to  overcome  economic  shocks 
more easily. During the COVID-19 pandemic, the involvement of the social partners 
has  been  most  meaningful  in  Member  States  with  well-established  social  dialogue 
structures, as this enabled social partners to make a meaningful difference. 23 

1.3. Long-term impact of the COVID-19 on productivity growth  

The  current  crisis  is  having  a  negative  impact  on  productivity  growth,  which  was 
already low before the crisis. If not addressed, it could leave scars on potential output in the 
medium to longer term and further hold back the process of real convergence. In the long run, 
economic growth is largely driven by productivity improvements, or the ability of societies to 
innovate and adopt new technologies (so-called Total Factor Productivity). Labour and total 
factor productivity growth in euro area, which was already low before the Global Financial 
Crisis,24 have worsened since then (Graph 11).25 From the mid-1990s, both labour and total 

20  Research  and  development  (R&D)  and  innovation  (R&I)  are  important  drivers  of  growth  but  research 
intensity  in  the  euro  area  is  still  lagging  behind  other  advanced  economies.  For  example,  in  2018,  R&D 
spending  in  the  euro  area  was  around  2.2%  of  GDP.  This  is  well  below  R&D  spending  in  the  US  (2.8  %  of 
GDP), Japan (3.3% of GDP) and Korea (4.5% of GDP). See Eurostat, Intramural R&D expenditure (GERD) by 
sectors of performance.  
21  For  more  details,  see  Annoni,  P.  and  Dijkstra,  L.,  “The  EU  Regional  Competitiveness  Index”,  Publication 
Office of the European Union, 2019. 
22  See  OECD,  “From  pandemic  to  recovery:  Local  employment  and  economic  development”,  OECD  Policy 
Responses to Coronavirus (COVID-19), 27 April 2020 http://www.oecd.org/coronavirus/policy-responses/from-
pandemic-to-recovery-local-employment-and-economic-development-879d2913/. 
23 European Commission (2020), ‘Employment and Social Developments in Europe 2020’. 
24  Fernald,  J.  and  R.  Inklaar  (2020),  “Does  Disappointing  European  Productivity  Growth  Reflect  a  Slowing 
Trend? Weighing the Evidence and Assessing the Future,” FRB of San Francisco WP 2020-22. 

13 

 
 
                                                 
factor  productivity  growth  in  euro  area  have,  on  average,  remained  lower  than  in  the  US26 
(Graph  12),  especially  so  since  the  Global  Financial  Crisis.27  Differences  across  countries, 
and regions, are also stark in some cases and have implications for the functioning of EMU.28 

Graph 11: Labour productivity and  
TFP growth in the EA-19 in 1996-2019 

Graph 12: Labour productivity and  
TFP growth in the US in 1996-2019 

GDP per Capita
Labour productivity
Total factor productivity
Average value of Labour Productivity (1996-2019)
Average value of Labour Productivity (2008-2019)

% 

GDP per Capita
Labour productivity
Total factor productivity
Average value of Labour Productivity (1996-2019)
Average value of Labour Productivity (2008-2019)

4
3
2
1
0
-1
-2
-3
-4
-5

% 

4
3
2
1
0
-1
-2
-3
-4
-5

1996 1999 2002 2005 2008 2011 2014 2017

1996 1999 2002 2005 2008 2011 2014 2017

Source: Ameco. 

Source: Ameco. 

There is significant uncertainty on the likely impact of the COVID-19 pandemic but it 
risks having a permanent effect on production factors and translating into lower growth 
in  labour  productivity  (and  lower  potential  output)  and  incomes.  There  are  several 
channels  through  which  the  COVID-19  shock  could  impact  labour  productivity  in  the  euro 
area in the medium term:  

  First,  the  pandemic  is  expected  to  lead  to  a  large  contraction  in  business 
investment,  which  in  turn  will  translate  into  a  lower  level  of  capital  stock  and 
reducing labour productivity. In the recent past, so-called “biological shocks” have 
had  a  permanent  impact  on  productivity,  through  heightened  uncertainty  and  a 
negative  impact  on  investment.  For  example,  a  recent  World  Bank  study  on  four 
epidemics  since  2000  -  SARS  (2002-03),  MERS  (2012),  Ebola  (2014-15),  and  Zika 
(2015-16)  -  found  that  the  average  lasting  impact  on  labour  productivity  and  output 
amounted to 4% cumulatively after three years.29 In the face of high uncertainty about 
future sales prospects, cost of funding and potentially more difficult access to credit, 

25  In  the  aftermath  of  the  previous  crisis  real  convergence  stalled  due  to  a  stronger  decline  in  productivity 
(especially  TFP)  in  the  catching-up  euro  area  countries  compared  to  the  rest  of  the  euro  area.  See  also 
Chiacchio,  Gradeva,  and  López-García  (2018),  “The  post-crisis  TFP  growth  slowdown  in  CEE  countries: 
Exploring the role of Global Value Chains”, ECB Working Paper, No. 2143. 
26  In  the  period  1996-2019,  the  average  growth  rate  of  labour  productivity  in  the  euro  area  was  0.8% (versus 
1.6% in the US), while TFP growth rate was 0.5% (versus 1.0% in the US). 
27 Cette, G., J. Fernald, and B. Mojon. (2016.), "The Pre-Great Recession Slowdown in Productivity." European 
Economic Review 88(C): 3-20. 
28 For more details, see Diaz del Hoyo, J. L. et al, “Real convergence in the euro area: a long term perspective”, 
ECB occasional paper series, N. 203, December 2017. 
29    For  more  details,  see  A.  Dieppe  (2020),  “Global  Productivity:  Trends,  Drivers,  and  Policies,”  Advance 
Edition. World Bank. 

14 

 
 
 
 
 
                                                                                                                                                        
firms  are  likely  to  postpone  or  cancel  investment  plans.30  Moreover,  revenue  losses 
during  the  lockdown  and  the  costs  incurred  to  adapt  to  the  pandemic  may  constrain 
firms’  ability  to  finance  investment  projects  in  the  near  term,  and  longer  if  the 
increase in debt leads to deleveraging needs.  

  Second, weaker business  investment  means lower accumulation of physical and 
human  capital  that  could  also  translate  into  lower  TFP  growth.  The  slower 
accumulation  of  capital  and  slower  adoption  of  capital-embodied  new  technologies 
could  feed  back  into  lower  labour  productivity.31  Weak  aggregate  demand  in  the 
aftermath  of  the  Global  Financial  Crisis  drove  the  sharp  fall  in  private  fixed 
investment.  This  drop  is  likely  to  have  contributed  to  subdued  labour  productivity 
growth  not  only  by  weakening  the  contribution  of  capital  deepening,  but  also  by 
affecting  TFP  growth  itself  through  a  slower  adoption  of  new  technologies.32  In 
addition, TFP growth could be lower as the lack of face-to-face contact could hinder 
knowledge acquisition and transfer. 

  Third,  weaker  trade  and  foreign  direct  investment  flows,  accompanying  a 
potential re-centring of global  value chains, could further dampen productivity 
growth in the euro area. There is evidence of a positive relationship between trade 
and  labour  productivity.33  Plummeting  global  trade  in  2020,  –  global  imports 
(excluding the euro area) are expected to plunge by 10.3% in 2020,  almost twice the 
level of the drop in world output – has been a distinguished feature of the COVID-19 
crisis.  Weaker  trade  growth  could  impact  upon  the  pace  of  technology  diffusion 
across countries and restrict competitiveness between firms, limiting the pressure on 
European firms to increase productivity. The supply chain risks34 and the potential35 
re-centring  of  global  value  chains’  activities  could  have  an  ambiguous  impact  on 
productivity. On the one hand, re-shoring towards Europe could reduce efficiency and 
productivity gains, which have been important drivers behind the rise of global value 
chains.  On  the  other  hand,  the  re-shoring  phenomenon  may  force  higher  capital 
intensity, which could positively impact capital deepening. 

30  See  also  “Business  and  consumer  survey  results  for  April  2020”,  which  expected  a  decrease  in  industrial 
investment although a considerable part of replies was collected before strict COVID-19 containment measures. 
31 See G. Adler, R. Duval, D. Furceri, S. Kılıç Çelik, K. Koloskova, M. Poplawski Ribeiro (2017). "Gone with 
the Headwinds; Global Productivity," IMF Staff Discussion Notes 2017/004, IMF. 
32 Based on data for 112 countries over 1970–2014, IMF empirical estimates of this effect suggests that falling 
investment may be responsible for lowering TFP growth by nearly 0.2 percentage points per year in advanced 
economies  over  the  post-crisis  period.  See  G.  Adler,  R.  Duval,  D.  Furceri,  S.  Kılıç  Çelik,  K.  Koloskova,  M. 
Poplawski  Ribeiro  (2017).  "Gone  with  the  Headwinds;  Global  Productivity,"  IMF  Staff  Discussion  Notes 
2017/004, International Monetary Fund. 
33  For  more  details,  see  “Does  trade  play  a  role  in  helping  to  explain  productivity  growth?”,  ECB  Economic 
Bulletin, Issue 7, November 2017. https://www.ecb.europa.eu/pub/pdf/other/ebbox201707_01.en.pdf. 
34 See OECD, “COVID-19 and global value chains: Policy options to build more resilient production networks”, 
OECD Policy Responses to  Coronavirus (COVID-19), 3 June  2020.   http://www.oecd.org/coronavirus/policy-
responses/COVID-19-and-global-value-chains-policy-options-to-build-more-resilient-production-networks-
04934ef4/. 
35 Tough Global Value Chains have been impacted, the existence of complex value chains is expected to persist 
as globalisation is already too advanced for a sharp reversal. See, for instance, Miroudot, S., “Resilience versus 
robustness 
June  2020. 
https://voxeu.org/article/resilience-versus-robustness-global-value-chains.     

in  global  value  chains:  Some  policy 

implications”,  VoxEU.org,  18 

15 

 
 
                                                 
2.  The macroeconomic policy stance  

In light of the ongoing COVID-19 crisis, a broader policy mix in which monetary, fiscal 
and  structural  policies  interact  can  better  support  a  sustainable  recovery  over  the 
medium  term.  In  a  context  of  monetary  policy  at  the  zero  lower  bound  and  limited  fiscal 
space, the current economic situation requires a  supportive, coordinated comprehensive and 
consistent  broad  policy  mix,  in  particular  to  limit  any  long-term  negative  impact  on  the 
functioning  of  markets,  reduce  significant  economic  divergence  and  imbalances  within  the 
euro  area  and,  more  broadly,  avoid  negative  consequences  on  potential  economic  growth. 
Stepping  up  structural  reforms,  while  taking  into  account  country-specific  circumstances, 
complements and reinforces the other two pillars. New simulations presented in Box 2 (see 
section  3)  using  DG  ECFIN’s  QUEST  model  provide  further  evidence  that  labour  and 
product market reforms can have material growth benefits over the medium term.  

Graph 13: ECB deposit rates and balance sheet 

2,00

% 

1,50

1,00

0,50

0,00

-0,50

ECB deposit facility rate

EONIA

Balance sheet total (rhs)

EUR bn 

400

300

200

100

0,0

-1,0

-2,0

-3,0

-4,0

-5,0

-6,0

-7,0

-8,0

-9,0

0

-10,0

Graph 14: Government budget balance,  
euro area 
Structural budget balance
Headline budget balance

% GDP 

forecast 

11

12

13

14

15

16

17

18

19

20

10 11 12 13 14 15 16 17 18 19 20 21

Source: ECB. 

Source: European Commission. 

In  light  of  the  unprecedented  economic  contraction  in  the  euro  area  and  to  safeguard 
the medium-term price stability objective36, the ECB has reacted forcefully and quickly 
by taking additional monetary policy easing measures, thus ensuring an accommodative 
stance (Graph 13). The ECB’s measures can be grouped into three broad areas: i) provision 
of  additional  liquidity  to  banks37;  ii)  easing  of  collateral  requirements;  and  iii)  substantial 
additional  purchases  of  public  and  private  sector  assets.  The  ECB  announced  substantial 
additional  purchases  of  public  and  private  sector  assets,  which  will  amount  to  EUR  1470 

36 The ECB has defined price stability as a year-on-year increase in the Harmonised Index of Consumer Prices 
(HICP) for the euro area of below 2%. In the pursuit of price stability, the ECB aims at maintaining inflation 
rates below, but close to, 2% over the medium term. 
37 The additional liquidity provided to banks includes  additional Long-Term Refinancing Operations (LTROs) 
and  a  new  series  of  seven  pandemic  emergency  longer-term  refinancing  operations  (PELTROs),  priced  25bp 
below  the  average  MRO  rate  prevailing  over  the  life  of  the  operation.  Moreover,  the  ECB  decided  on  more 
favorable terms for existing and outstanding  targeted operations with long maturities (TLTRO III). Lastly,  the 
ECB also offered daily USD-denominated refinancing operations within an enhanced USD swap line agreement 
with the Federal Reserve. 

16 

 
 
 
 
 
                                                 
billion under the Asset Purchase Programme (APP, EUR 120 billion until the end of 2020) 
and the Pandemic Emergency Purchase Programme (PEPP, EUR 1,350 billion until at least 
mid-2021).  The  intended  aim  of  these  measures  was  to  maintain  favourable  financial 
conditions and contribute to the easing of the policy stance. Along with the ECB's monetary 
policy measures, macro-prudential authorities and supervisors implemented a wide range of 
targeted measures with the aim to limit financial stability risks and spillovers between market 
segments.38 

2.1 The fiscal policy stance  

On the fiscal side, the EU and its Member States took unprecedented actions to counter 
the  negative  impact  of  the  COVID-19  shock.  On  20  March  2020,  the  Commission 
concluded  that  the  EU  economy  was  experiencing  a  severe  economic  downturn  and  the 
conditions  to  activate the  general  escape  clause  of the Stability  and  Growth Pact  were thus 
met.39 This conclusion was endorsed by the ECOFIN Council. Consistent with the activation 
of  the  general  escape  clause,  euro  area  Member  States  introduced  sizeable  emergency 
budgetary measures aimed at supporting businesses and households (see Box 1). In addition, 
the  European  Commission  and  the  Union  adopted  a  temporary  framework  to  use  the 
flexibility under EU state aid rules to support the economy in the context of the coronavirus 
crisis  40  and  put  forward  measures  to  provide  emergency  liquidity,  such  as  the  CRII41  and 
CRII+ packages, as well as a European Strategy for the Recovery, which includes the Next 
Generation  EU42,  with  the  Resilience  Recovery  Facility  (RRF)  as  its  central  pillar.  The 
Facility will provide large-scale financial support for investments and reforms in the Member 
States, with the aim of fostering economic and social convergence and resilience. In addition, 
national  and  EU  authorities  have  put  in  place  exceptional  liquidity  support,  mainly  via 
guarantees to ensure the flow of credit, including through the new SURE instrument and the 
Pandemic Crisis Support by the European Stability Mechanism (ESM).  

38  Measures  included  lower  regulatory  capital  requirements  for  banks,  the  temporary  permission  to  operate 
below certain capital buffer requirements and acceptance of lower liquidity coverage ratios, as well as taking a 
flexible approach in the supervisory treatment of NPLs covered by state guarantees. At the same time, several 
national authorities decided to release countercyclical capital buffers (CCyB) or to revoke previously announced 
CCyB increases and reduced other buffer requirements such as for structural risks. 
39 The Council endorsed this assessment on 23 March. 
40 For more details, see https://ec.europa.eu/commission/presscorner/detail/en/ip_20_1872 
41 The CRII (Coronavirus Response Investment Initiative), in force as of 1 April 2020, gives Member States an 
upfront  cash  injection  of  EUR  8  billion  from  the  EU  cohesion  funds  which  could  accelerate  up  to  EUR  37 
billion of European public investment to fight the coronavirus. The CRII+ (Coronavirus Response Investment 
Initiative Plus) extended the scope of support of the funds, provided immediate liquidity and gave flexibility in 
programme  amendments.  See  https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?  uri=CELEX  :52020  PC 
0113&from=EN  
42 The EU Commission estimates that effective implementation of Next Generation EU can deliver around 1¾ 
% of additional EU GDP in 2021 and 2022, rising to 2¼% by 2024, and create 2 million jobs.  See SWD(2020) 
98 final - Identifying Europe's recovery needs. 

17 

 
 
 
 
                                                 
BOX 1: Overview of national fiscal measures put in place to respond to the crisis 

Member States have announced and taken sizeable emergency measures in response to 
the  COVID-19  pandemic.43  Discretionary  budgetary  measures  with  a  direct  budgetary 
impact that were announced by euro area Member States by 22 October 2020 are estimated at 
4.0%  of  GDP  in  2020  (Table  1).  These  discretionary  measures  come  on  top  of  automatic 
stabilisers – the non-discretionary part of fiscal policy. The discretionary components consist 
primarily of additional spending amounting to 3.6% of GDP including health care and other 
epidemic-related  spending  (0.6%  of  GDP)  and  other  items  including  subsidies  to  specific 
sectors and top-ups to the regular unemployment benefit schemes (3.0% of GDP). Tax relief 
measures amount, on average, to some 0.4% of GDP.  

Table 1: National fiscal measures in the euro area in response to the COVID-19 crisis, 2020 - 2022 

Source: ECFIN staff calculations. 

Most  of  the  measures  have  been  announced  as  temporary,  whilst  some  have  been 
extended and new ones supporting the recovery will have effects beyond 2020. Currently, 
more than half of the measures is expected to have an impact only in 2020. Going forward, 
the impact of the measures are expected to further decrease in 2022. ”Emergency” measures 
in direct response to the outbreak of the pandemic were clearly announced as temporary. At 
the same time, the resurgence of the spread of the COVID-19 may lead to a prolongation of 
existing and/or adoption of new measures leading to budgetary effects also in 2021, beyond 

43 The results of the identification and quantification of measures presented in this section should be considered 
work-in-progress.  The  estimation  of  the  budgetary  impact  is  subject  to  revision  as  new  information  becomes 
available or Member States announce new measures. The estimated budgetary impact also depends on statistical 
classification decisions and guidance by national statistical authorities and Eurostat. 

18 

26-10-2020EA-19bln EUR% of GDPbln EUR% of GDPbln EUR% of GDPInitiatives by the Member States1A.  Measures with a direct budgetary impac2 448.34.0-237.6-2.0-130.6-0.91. Expenditure400.93.6-223.1-1.9-114.4-0.81. a) Health care 69.30.6-38.1-0.3-19.4-0.11. b) Other333.03.0-184.9-1.6-94.9-0.7 of which impact from guarantees*10.50.1-7.2-0.1-0.70.0public investment*10.90.15.90.0-10.3-0.1short-time work schemes*111.81.0-84.5-0.7-27.3-0.22. Revenue47.40.4-14.5-0.1-17.3-0.1B. Liquidity measures without a direct budgetary impact2276.620.31. Tax delays 121.31.1-16.7-0.12. Public guarantees (available framework)31894.016.9of which current take-up (actual contingent liability)426.73.80.00.03. Others261.42.32020202120221 The amounts included cover the impact of nationally-financed measures, net of funding privided e.g., by EU initiatives.2 In line with the established principles for recording fiscal policy measures under the no-policy-change assumption, the impact of the measures is given in increments compared to year t-1 in accrual terms (ESA2010). GDP projections are based on the Commission 2020 autumnm forecast.3 Figures refer to the maximal public funds involved id all of the available guarantees were taken-up. Guarantees to EU and international level instruments are excluded. For Germany, the size of available (not only new guarantee schemes) is included, while the overall guarantee framework is acutally unlimited.* Reporting is optional, only included for MS where reliable estimates are available; thus figures are likely to represent a lower bound. 
 
 
 
                                                 
what was projected until now.  

In  addition  to  the  direct  budgetary  support  for  businesses  and  households,  euro  area 
Member States have provided ample liquidity support with no direct budgetary impact 
to date, estimated at 20.3% of GDP, to counter the economic fallout of COVID-19. This 
primarily  includes  public  guarantees  (16.9%  of  GDP44)  and  tax  deferrals  within  the  year 
(1.1% of GDP) as well as other measures (2.3% of GDP) to provide liquidity support. Some 
of these measures could have a delayed impact, as some of the postponed tax obligations may 
never be settled, for example due to  corporate bankruptcies and in  particular in  light  of the 
second  wave.  The  comparability  of  these  figures  across  Member  States  is  particularly 
challenging given the diversity and complexity of the guarantee frameworks. 

The euro area fiscal  stance is  expected to be  strongly  expansionary in 2020 due to the 
sizeable emergency fiscal measures taken by Member States.45 After reaching historically 
low levels in 2018-19 (0.5% GDP), the euro area general government deficit is projected to 
increase to 8.8% of GDP in 2020 (Graph 14 and Table 2). The expenditure-to-GDP ratio is 
expected  to  increase  by  around  8%  of  GDP  in  2020  (Table  2),  reflecting  the  working  of 
automatic stabilisers and unprecedented discretionary policy measures (including the increase 
in health expenditures) adopted to cushion the economic and social impact of the pandemic.46 
At the same time, revenue is expected to fall in line with nominal GDP in 2020, reflecting the 
decrease  in  tax  receipts,  capturing  both  lower  income  tax  revenues,  as  well  as  weaker 
consumption tax collection and declining import duties.  

Table 2: General Government budgetary position (per cent of GDP) in the euro area, 2016 – 2022 

Note: contributions to change in actual balance may not add up to total due to rounding.  
Source: European Commission 2020 Autumn Forecast, Ameco. 

44 The figure refers to the available public guarantee framework, i.e. the maximum public funds that would be 
committed if all of the available guarantees were taken-up. 
45 See 2020 Autumn Economic Forecast. 
46  These  measures  are  assumed  to  be  phased  out  gradually  in  the  course  of  2021  under  a  no-policy-change 
assumption. 

19 

2016201720182019202020212022Total receipts (1)46.346.246.546.446.546.045.8Total expenditure (2)47.747.246.947.155.252.450.5Actual balance (3) = (1)-(2)-1.5-0.9-0.5-0.6-8.8-6.4-4.7Interest expenditure (4)2.11.91.81.61.61.41.3Primary balance (5) = (3)+(4)0.61.01.41.0-7.2-5.0-3.4One-offs (6)0.1-0.1-0.1-0.20.00.00.0Cyclically-adjusted budget balance (7)-1.0-1.3-1.2-1.5-4.8-4.3-3.6Cyclically-adjusted primary balance (8) = (7)+(4)1.10.70.60.1-3.2-2.9-2.3Structural budget balance (9) = (7)-(6)-1.1-1.2-1.1-1.3-4.8-4.3-3.7Structural primary balance (10) = (7) -(6)+(4)1.10.80.70.3-3.2-2.9-2.3Change in actual balance:of which change in:                 - Cycle0.50.80.40.1-4.81.81.0                - Interest (inverse)0.20.20.10.20.00.20.1                - One-Offs0.2-0.20.0-0.10.10.00.0                - Structural primary balance-0.4-0.3-0.1-0.4-3.50.30.6Change in structural budget balance-0.2-0.10.1-0.2-3.50.50.7Public debt (% GDP)92.289.787.785.9101.7102.3102.6 
 
 
 
                                                 
The  fiscal  stance  in  2021  is  expected  to  remain  supportive  at  both  euro  area  and 
national  level.  Given  the  current  high  level  of  uncertainty,  withdrawing  fiscal  support  too 
early is a primary source of concern, as it could put the still-fragile recovery in jeopardy. The 
estimated decline in the structural primary deficit of around ½% of GDP in 2021 reflects the 
phasing out of temporary support measures introduced in 2020 (Table 2).47 After excluding 
the emergency measures, the underlying fiscal stance would  appear to remain supportive in 
2021, also thanks to measures announced in the 2021 draft budgetary plans. In addition, the 
implementation  of  Recovery  and  Resilience  Plans,  which  is  only  partially  reflected  in  the 
Autumn 2020 Forecast, should contribute to a more supportive fiscal stance in the euro area 
in 2021. 

A  significant  deterioration  of  the  debt-to-GDP  positions  is  also  projected  in  line  with 
what is foreseen in other  major advanced economies  (Graph 15). The euro area debt-to-
GDP ratio is forecast to increase by 16 % of GDP, compared to 2019, to just above 100% of 
GDP in 2020 (Graph 16) and to remain around this level by 2022. Overall, the primary deficit 
will  continue  to  weigh  on  debt  dynamics  in  2021  and  2022,  but  a  favourable  interest  rate-
growth differential should help contain the projected increase. In line with the increase in the 
debt-to-GDP ratio, government gross financing needs (GFN) in the euro area are estimated to 
reach to around 25% of GDP in 2020 (against less than 15% of GDP in 2019). This rise stems 
mainly  from  large  new  financing  requirements  (i.e.  widened  budgetary  deficits),  which 
compound with the need to rollover accumulated debt. They are expected to decrease below 
20% of GDP by 2022.  

Graph 15: Changes in the debt-to-GDP ratio, in 
the euro area and other advanced economies 

Graph 16: Debt-to-GDP projections in the euro 
area 

Change 2020 Change 2021-22

% of GDP 

p10
p20_p40
p60_p80

p10_p20
p40_p60
p80_p90

% of GDP 

115

110

105

100

95

90

85

2019

2021
Source: European Commission. 

2020

2022

2023

2024

2025

L
E

T
I

S
E

E
B

Y
C

T
P

R
F

I
S

K
S

T
A

T
M

E
D

T
L

L
N

V
L

I
F

E
E

E
I

U
L

P
J

S
U

A
E

Source: European Commission. 

Overall,  the  debt  sustainability  assessment  suggests  that  the  debt  position  remains 
sustainable  over  the  medium-term,  notwithstanding  risks  and  significant  uncertainty. 
The debt-to-GDP ratio in the euro area is expected to stabilise (Graph 16) over the medium 
term as the impact of the COVID-19 crisis on public finances gradually unwinds.48 However, 

47 The gradual withdrawal of the temporary emergency measures is expected, assuming that the pandemic wanes 
and  the  negative  economic  impact  of  containment  measures  tapers  off.  At  the  same  time,  these  temporary 
emergency measures distort the traditional fiscal indicators of the fiscal stance. 
48  The  2020-22  Commission  baseline  incorporates  fiscal  policy  measures  (adopted  or  at  least  credibility 
announced)  and  information  as  of  22  October  2020.  Starting  in  2023,  countries  are  generally  assumed  to 

20 

30

20

10

0

-10

-20

 
 
 
 
                                                 
 
there  is  significant  uncertainty  over  this  projection  given  the  unprecedented  nature  of  the 
crisis  and  uncertainty  about  its  future  evolution,  notably  the  duration  of  social  distancing 
measures and the strength of the recovery. According to stochastics simulations (Graph 16), 
the  debt-to-GDP  ratio  is  expected  to  stand  between  more  than  95%  and  110%  of  GDP  by 
2025 with an 80% probability. Relatedly, contingent liability risks may arise from the private 
sector, via the possible materialisation of government guarantees put in place to support firms 
and  self-employed,  representing  about  20%  of  GDP  in  2020  (according  to  Autumn  2020 
estimates).  On  the  other  hand,  several  mitigating  factors  exist  including  the  lengthening  of 
debt maturities in recent years, relatively stable financing sources, historically low borrowing 
costs, and EU initiatives such as the temporary Support to mitigate Unemployment Risks in 
an Emergency (SURE) and, importantly, the Recovery and Resilience Facility (RRF). 

The  European  Recovery  and  Resilience  Facility  (RRF)  is  expected  to  support  debt 
dynamics.49 The provision of EU grants under the RRF should allow fiscal stimulus without 
raising  national  debt  in  the  medium-term,  with  this  effect  being  more  pronounced  for  the 
highly-indebted countries and/or countries receiving a relatively larger amount of funds. The 
overall  impact  will  depend  on  several  factors  such  as  the  composition  of  public  spending 
financed by these funds, the (strength/persistence of) fiscal multiplier effects on growth, and 
the  degree  of  additionality  of  the  funds  received  (versus  other  sources  of  financing).  In 
addition,  RRF loans are expected to  present  attractive funding conditions  for most Member 
States and in particular those more affected by the crisis. 

2.2 Expenditure Policy  

The crisis has significantly impacted public expenditures across the euro area, placing 
considerable strains on Member States’ public finances. The large part of the increase in 
expenditures has been directed to support economies and citizens, as public support has been 
extended  to  keep  businesses  and  households  afloat  (see  Box  2).  Going  forward,  Member 
States  plan  to  phase  out  temporary  support  measures  to  firms  and  households,  when  the 
epidemiological and economic conditions allow and to plan this in a way that mitigates the 
social  and  labour-market  impact  of  the  crisis,  while,  at  the  same  time,  aiming  at  achieving 
prudent medium-term fiscal positions.  

In a moment of unprecedented fiscal expansion, improving the composition of national 
budgets  appears  particularly  relevant.  Moreover,  the  quality  and  efficiency  of  public 
finances also play an important role. In order to create fiscal space, expenditure reviews are 
utilised  across  Member  States  to  rationalise  public  spending  and  direct  it  to  areas,  and 

gradually adjust their structural primary balance to return to the level that was forecasted for year 2021 in the 
(pre-pandemic)  Commission  2019  Autumn  Forecast.  In  order  to  avoid  an  unrealistic  fiscal  path,  the  yearly 
adjustment of the structural primary balance is capped at 0.6 % of GDP.  
49  Given  the  limited  information  on  the  use  of  RRF,  the  approach  to  its  incorporation  in  the  2020  Autumn 
Forecast, and thus in the figures reported in the document, is based on technical assumptions. In particular, the 
forecast  only  incorporates  those  measures  that  are  credibly  announced  and  sufficiently  detailed  in  the  draft 
national budgets. Similarly, no financing from the RRF has been included on the revenue side of the budgetary 
projections (only the pre-financing). 

21 

 
 
                                                                                                                                                        
individuals, in greater need. Engaging in spending reviews in large areas of expenditure such 
as  pensions  or  health  can  help  improve  the  efficiency  of  spending  while  also  ensuring  the 
long-term  sustainability  of  public  finances.  Public  procurement  of  goods  and  services 
amounted  to  some  14%  of  GDP  in  2019.50  However,  according  to  the  Single  Market 
Scoreboard,  there  are  still  large  differences  between  Member  States  in  terms  of  public 
authorities’  performance  in  getting  the  best  value  for  money  in  their  purchases.51  The 
efficiency of public procurement systems is especially important in this recovery process and 
successful  twin  green  and  digital  transitions.  In  addition,  efficient  investments  can  also 
strengthen  health  systems.  The  COVID-19  crisis  provided  evidence  that  health  systems  in 
Member  States  were  not  adequately  prepared  to  face  this  challenge  due  to  a  number  of 
structural  weaknesses  and  a  lack  of  resources  (facilities,  staff  and  supplies).  Resilient, 
adequately resourced, efficient and accessible health systems can safeguard better the health 
of the population, which is fundamental to a well-performing economy. 

Public  investment,  which  has  remained  stagnant  in  net  terms  for  the  good  part  of  the 
last  decade,  is  forecast  to  increase  to  some  3-3¼%  of  GDP  in  2021  on  the  back  of 
decisive policy responses by Member States. This would represent a marked break with the 
past when public investment was slashed in economic downturns  (Graph 17).  

Graph 17: Government expenditure, euro area 

Graph 18: Structure of taxation by economic function of 
the tax base (2018) 

Government investment expenditure
Compensation of employees (rhs)
Social benefits (rhs)

forecast 

% GDP 

4

4

3

3

2

Other taxes
Recurrent taxes on immovable property
Consumption taxes (other than environmental)
Environmental taxes
Labour taxes (including social contributions)

22

20

18

50

% of GDP 

40

16

30

14

12

10

8

20

10

0

05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21

Source:  European  Commission  2020  Autumn  Forecast,  Ameco,  European 
Commission, Taxation trends in the European Union, 2020. 

I
F

T
I

I
S

R
F

L
N

L
E

T
P

Y
C

T
A

S
E

E
B

E
D

K
S

U
L

9
1
-
A
E
Note: “other taxes” includes all taxes that are not labour, consumption, environmental, 
or recurrent property taxes (e.g., capital taxes such as on corporate income, capital gains 
or inheritances). Labour taxes includes employers’ and employees’ social contributions 
Source: European Commission 2020 Autumn Forecast, Ameco, European Commission, 
Taxation trends in the European Union, 2020. 

T
M

E
E

V
L

T
L

E
I

The  Recovery  and  Resilience  Facility  and  the  EU  budget  has  the  potential  to  boost 
Member States’ efforts towards a sustained recovery of investment in the medium term. 

50 On this see COM(2017) 572,  Making Public Procurement work in and for Europe. 
51  The  quality  of  procurement  data  submitted  to  TED  (Tenders  Electronic  Daily)  and  an  early  adoption  of 
eForms in their broad scope (including voluntary  fields) are instrumental to achieve successful twin green and 
digital  transitions.  See  “Single  Market  Scoreboard: Performance  per  policy  area  –  Public  Procurement”,  https 
://ec.europa.eu/internal_market/scoreboard/performance_per_policy_area/public_procurement/index_en.htm. 

22 

 
 
 
 
 
                                                 
Public  investment  can  support  the  recovery  and  can  also  help  to  address  long-term 
challenges. For example, substantial and coordinated public investments are needed to deliver 
on the Union’s climate objectives, in both adaptation and mitigation, as well as compensatory 
measures to support those most negatively affected by the transition.  In this context, ‘green 
budgeting’  tools  can  help  address  the  challenges  of  climate  mitigation  and  environmental 
protection.52  Similarly,  investments  in  skills  and  in  improving  the  digital  environment  will 
contribute to the digitalisation of euro area economies and public administration, as well as 
supporting  citizens  in  adapting  to  a  changing  working  environment,  favouring  the 
reallocation to new growth sectors.  

2.3 Revenue Policy  

Lower potential growth combined with higher debt makes the role  of revenue policies 
even more crucial. The COVID-19 crisis and the consequent slowdown in economic activity 
are expected to lead to a fall in the level of total receipts in 2020 in line with the contraction 
in  GDP  (Table  2).  Incomes  have  declined,  consumption  has  contracted  and  some  firms  are 
expected  to  incur  large  losses  thus  leading  to  a  significant  decline  in  corporate  tax  receipts 
putting a strain on public revenues. Moreover, the VAT Gap53 is projected to increase further 
in 202054, also due to a sudden decline in the tax base and the possible increase in tax fraud in 
some sectors of the economy. Finally, tax measures have also been one of the tools used by 
Member States to respond to the peak of the crisis (Box 1) with the primary aim to lower the 
pressure on companies’ and households’ liquidity.  

Notwithstanding  the  challenges  arising  from  the  crisis  and  the  immediate  pressure  on 
revenue, there is still scope to make tax systems more growth-and environment-friendly 
going forward. The tax burden in the euro area (at 40.5% of GDP) remains high, and above 
other  advanced  economies.  Moreover,  the  overall  tax  burden  is  largely  skewed  towards 
labour and production factors, with more growth-friendly environmental taxes representing a 
very small share of tax revenues55 (Table 3 and Graph 18). The tax wedge on labour in the 
majority  of  euro  area  Member  States  remains  much  higher  than  the  OECD  average, 
corresponding to around 36% of labour costs.56 Reducing employee/employer social security 
contributions  or  personal  income  taxes  has  the  potential  to  stimulate  labour  supply,  create 
work incentives and support job creation.  

52 A recent review conducted by the Commission pointed to a limited use of green budgeting practices across 
Member States, with a variety of different approaches. For more detail, see “Development in Public Finances in 
the EMU”, Report on Public Finances in the EMU 2019 (2020).  
53 The VAT Gap is the difference between the expected VAT revenues and VAT actually collected.  
54  Study  and  Reports  on 
www.ec.europa.eu/taxation_customs/sites/taxation/files/vat-gap-full-report-2020_en.pdf. 
55  Environmental  taxes  could  have  a  long-lasting  positive  impact  on  growth  and  reduction  of  negative 
externalities  although  they  may  disproportionally  affect  low-income  individuals,  due  to  increase  in  prices  of 
basic goods, including heating and electricity. 
56 For more details, see 2021 Joint Employment Report (2020) and “Tax wedge on labour: shifting tax burden 
from labour to other forms of taxation”, Technical Note for the Eurogroup, ARES (2020). 

the  EU-28  Member  States 

(2020)  Final  Report 

the  VAT  Gap 

in 

23 

 
 
                                                 
Table 3. Characteristics of Tax Categories 

Note: Tax governance includes tax administration, including tax collection and compliance. 
Source: European Commission, Tax policies in the European Union, 2020 Survey; Tax Wedge On Labour: Shifting Tax Burden From Labour. To Other 
Forms Of Taxation; Technical note for the Eurogroup. 

Rethinking the overall tax mix, including labour taxation, and ensuring a level-playing 
field could support inclusive and sustainable growth. In the current context, redistribution 
of tax would also ensure a fair burden-sharing of the effects of the crisis. High tax burden on 
labour,  particularly  for  low-income  and  second  earners,  can  be  an  impediment  for  job 
creation  and  labour  market  participation.  At  the  same  time,  environmental  taxation57  can 
contribute  to  sustainable  growth  by  incentivising  “greener”  behaviour  by  producers  and 
consumers58  although  they  could  have  adverse  distributional  effects,  by  putting  a 
comparatively  higher  burden  on  lower-income  households,  compensation  mechanisms  may 
be warranted.59 

In  addition  to  the  risks  to  the  revenue  linked to  the  COVID-19  crisis,  tax  competition 
and  a  race  to  the  bottom  in  corporate  taxation  poses  several  challenges  for  the  euro 
area. The average euro area top statutory corporate tax rate has been falling steadily in the 
last  two  decades,  from  27.8%  in  2004  to  23.4%  in  2020.60  Furthermore,  corporate  taxation 
systems currently do not ensure that profits are taxed where they are generated, particularly 
given the increasing digitalisation of the economy. The resulting tax competition can lead to 
sub-optimal  results  in  terms  of  resource  allocation  and  investment  decisions,  while  posing 
problems  for  economic  growth,  social  fairness  and  the  allocation  of  employment.  Together 
with tax avoidance, it also risks undermining faith in the fairness of the overall tax system. 
Recent studies find that tax competition among corporates entails more than EUR 35 billion 
of corporate tax revenues losses across the EU, annually. 61 Race to the bottom and aggressive 

57 The share of environmental taxes in total revenues is still well below the 10% 2020 target. See EU Flagship 
Initiative for a Resource-Efficient Europe. 
58 See Meyermans, E., et al., “Shifting taxes away from labour to strengthen growth in the euro area”, Quarterly 
Report on the Euro Area (QREA), Vol. 19, No. 1 (2020)/19 and European Green Deal. 
59 European Commission (2020), ‘Employment and Social Developments in Europe 2020’. 
60  “Taxation  Trends  in  the  European  Union,  2020  edition”,  Directorate-General  for  Taxation  and  Customs 
Union, European Commission. 
61  Álvarez-Martínez  ,  M.  et  al.,  2018.  How  Large  is  the  Corporate  Tax  Base  Erosion  and  Profit  Shifting?  A 
General Equilibrium Approach. CEPR Discussion Papers 12637 and Tørsløv, T., Wier, L. & Zucman, G., 2018. 
The  Missing  Profits  of  Nations.  NBER  Working  Paper  24701.  An  analysis  commissioned  by  the  European 
Parliament finds that the revenue loss from profit shifting within the EU amounts to about EUR 50-70 billion. 

24 

 
 
 
 
                                                 
tax  planning  could  also  create  strong  negative  spillovers  within  euro  area  Member  States, 
through the tax-induced redistribution effects.62  

In  the  context  of  a  growing  digital  economy,  there  is  evidence  that  companies  with 
digital  business  models  have  lower  tax  rates  than  more  traditional  businesses 
highlighting  concerns  around  the  degree  of  fairness  of  the  tax  system.  While  it  is  an 
internationally  agreed  principle  that  profits  should  be  taxed  where  value  is  created63,  the 
globalisation  and  digitalisation  of  the  economy  have  created  a  disconnect  between  where 
value is created and where taxes are paid, and companies engaged in digital activities often 
avoid  sharing  the  tax  burden  needed  to  finance  the  public  services.  In  the  context  of  its 
proposal on the digital service tax, the European Commission had estimated that companies 
with  digital  business  models  had  lower  tax  rate  than  more  traditional  businesses,  with  an 
effective average tax rate of 9.5% compared to 23.2%.64 While a number of jurisdictions have 
already  enacted  or  considered  national  services  taxes,  work  is  ongoing  within  the  OECD 
framework to reach a global-consensus based solution to address tax challenges arising from 
the  digitalisation  of  the  economy.65  The  pandemic  has  also  accelerated  the  shift  towards  e-
commerce, making it more urgent to make the EU VAT system better suited to the platform 
economy.66   

3.  Structural issues and reform developments 

Well-designed structural policies - consistent with the green and digital transitions - can 
further support the recovery, enhance economic and social resilience and facilitate the 
transmission  of  monetary  policy.  In  recent  years,  progress  in  reform  implementation  has 
been  limited  despite  efforts  to  strengthen  application  through  the  European  Semester.  New 
model  simulations  provide  further  evidence  on  the  effects  of  labour  and  product  market 
reforms, in terms of material growth benefits over the medium term (Box 2).  

BOX 2: Simulation of Policy Mix based on the QUEST model 

Along with monetary and fiscal support provided by Member States, structural 
reforms  can  ensure  a  lasting  recovery  and  sustainable  growth  prospects  in  the 
euro  area.  The  Recovery  and  Resilience  Facility  provides  an  opportunity  to 

62 In order to ensure a lasting, efficient and fair approach for international taxation, a number of initiatives have 
been put in place at the euro area and international levels to ensure fair taxation across countries.  Among these, 
the  EU  Anti Tax Avoidance  Package (2016);  the Union list of non-cooperative jurisdictions  for tax purposes; 
the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS). 
63 OECD/G20 Base Erosion and Profit Shifting Project (2013). 
64  For  more  details,  see  “Commission  Staff  Working  Document-  Impact  Assessment-  Accompanying  the 
document Proposal for a Council Directive laying down rules relating to the corporate taxation of a significant 
digital  presence  and  Proposal  for  a  Council  Directive  on  the  common  system  of  a  digital  services  tax  on 
revenues resulting from the provision of certain digital services”, SWD (2018) 81 final, 21 March 2018. 
65 Communiqué of G20 Finance Ministers & Central Bank Governors Meeting, 14 October 2020. 
66  See  EU  Commission  (2020)  “Fair  and  simple  taxation”  https://ec.europa.eu/taxation_customs/general-
information-taxation/eu-tax-policy-strategy/package-fair-and-simple-taxation_ en.  

25 

 
 
 
                                                 
undertake  needed  structural  reforms  that  could  have  significant  growth  benefits,  as 
shown in this box that uses DG ECFIN’s structural macro model QUEST67 to assess 
the GDP impact  of a set  of structural  reforms  included on top  of baseline monetary 
and fiscal support. The simulations illustrate that labour and product market reforms 
could  have  material  growth  benefits  over  the  medium  term.  The  model  analysis 
reflects  the  following  assumptions  for  the  simulated  product  and  labour  market 
reforms: 

  Reforms  lowering  the  administrative  burden68  implying  a  2  percentage-point 
mark-up reduction in the euro area economy together with 0.5% improvement 
in the level of TFP.  

  A 2 pp increase in labour force participation69 over a 10-year horizon.70  
  Structural reforms in the labour and product market are assumed to kick off in 

mid-2021, when emergency support by Member States starts waning.  

  The labour market component is phased in over 20 years, whereas the product 

market component materialises fully after 5 years. 

Most notable results of the simulations (expressed as a deviation from a baseline) are 
the following (Graph 19):  

  Labour  and  product  market  reforms  start  to  kick-in  by  2021.  The  growth 
benefits of these reforms are already visible in the same  year, even if only a 
small  part  of  the  associated  supply  expansion  will  have  materialized  at  that 
point. The reforms will take effect only gradually in the scenario; nonetheless, 
once their effects become more pronounced, structural reforms have a positive 
effect on GDP in the medium term. Specifically, by 2029 the projected level 
of GDP is 4.5% higher than in the baseline scenario.  

  Structural reforms can add 0.5 percentage points to  yearly GDP growth  over 
the decade on average, which appears particularly significant considering the 
low potential GDP growth prior to the COVID-19 crisis.  

  Strengthened  product  market  competition  can  reduce  the  profit  margins  of 
individual  firms  and  increase  efficiency  through  new  entrants  in  the  market. 
Both  elements  have  positive  effects  on  the  level  of  GDP.  Increasing  labour 
force  participation  through  reforms  would  furthermore  translate  into  a  2% 
increase  in  employment  (as  measured  by  hours  worked)  by  2029.  Similarly, 
consumption would benefit from an increase in the participation rate, through 
higher disposable income. 
In  the  long-run,  even  partially  closing  the  gap  in  terms  of  structural  reforms 
towards best performing countries could also have significant positive effects 

 

67 See Burgert  et  al.  (2020), ‘A  Global  Economy Version   of   QUEST:   Simulation   Properties’, European 
Economy Discussion Paper 126. 
68 For instance, policies including product market reforms, reforms to improve the business environment and the 
justice systems. 
69  Depending  on  Member  States,  there  could  be  different  reforms  leading  to  such  increase  in  labour  force 
participation, including reducing early retirement schemes, increasing the provision of child care, strengthening 
active labour market policies and training/education to improve employability. 
70  The  size  of  the  assumed  product  and  labour  market  reforms  on  GDP  is  purely  illustrative,  but  orders  of 
magnitude are informed by the scope for reforms as measured by halving the performance gap between the euro 
area average and the best performing EU Member States.  

26 

 
 
 
                                                 
on  convergence  within  the  euro  area,  as  the  effects  may  be  concentrated  in 
areas and countries lagging behind. 

Graph 19: Impact of product and labour market reforms on the level of euro area real GDP 
(deviation from baseline level) 

Product market
Labour market

% 

Emergency 
fiscal 
measures 

5

4

3

2

1

0

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029

Source: European Commission.  

There  are  several  areas  where  structural  and  institutional  factors  continue  hindering 
growth in the euro area and where wide-ranging reforms could support the euro area 
objectives  of  promoting  convergence  and  the  functioning  of  the  single  currency  area 
while  supporting  a  fair,  green  and  digital  recovery.71  The  remaining  of  this  section 
discusses structural weaknesses and reforms in the following areas:  

i) 
ii) 
iii) 
iv) 
v) 
vi) 

Single market integration;  
Labour markets and social protection; 
Labour market skills for the digital and green transition; 
Insolvency frameworks;  
Administrative and absorption capacity and other drivers of institutional quality;  
Risks of macroeconomic imbalances. 

3.1. Single market integration  

The  common  currency  and  the  single  market  have  been  working  in  tandem  to  create 
better  conditions  for  economic  stabilisation  and  long-term  growth.  The  euro’s  very 
rationale has been to facilitate the functioning of the single market. In turn, the single market 
has  the  potential  to  diminish  price  rigidities  that  undermine  both  the  monetary  policy 
transmission  mechanism  and  economic  resilience  in  the  euro  area.  Thanks  to  the  single 
market,  the  mobility  of  production  factors  can  allow  sectors  and  regions  to  limit  economic 
costs (e.g., unemployment) in response to shocks. The deeper integration of financial markets 
in  the  euro  area  can  notably  enable  further  risk-sharing  (see  section  5).  At  the  same  time, 

71 The importance of future-proofing the euro area economy through embracing the green and digital transitions 
is recognised and discussed widely in a number of European Commission documents, including in the Strategic 
Foresight  report  on  Future-proofing  the  EU;  the  documentation  on  the  European  Green  Deal;  the  Annual 
Sustainable Growth Strategy 2021; and the documentation on the Recovery and Resilience Facility. 

27 

 
 
 
 
 
 
 
                                                 
competitive sustainability requires openness and strong Single Market.72 In the longer term, 
the single market favours exports, investment, innovation and productivity.73  

The  single  market  has  not  fulfilled  its  full  potential  yet.74  In  fact,  the  European 
Commission75  estimated  that,  while  the  share  of  trade  within  the  single  market  amounts  to 
about 8-9% of EU GDP, further integration could increase this share to around 12% of GDP.  

Graph 20: Product market regulation and barriers 
in services and network sectors in 2018 

Graph 21: Unemployment rate and share of 
workers in job retention schemes 

Barriers in Services sectors
Barriers in Network sectors

% 

Assumed share of short time workers on zero hours
Unemployment rate 2020Q2
Unemployment rate 2020Q1

% 

30

25

20

15

10

5

0

3,5

3

2,5

2

1,5

1

0,5

0

OECD average

 Top 5 best
performing OECD
countries average

EA average

Note: The coded information is normalised over a zero to six scale, where a lower 
value reflects a more competition-friendly regulatory stance.  EA-19 average based 
on  population  shares.  Services  sectors  include:  retail  trade,  taxis  and  professions 
(lawyers, notaries, accountants, architects, civil engineers, estate agents). Network 
sectors include: energy, transport and e-communications. 
Source: OECD. 

Note: The share of short-time workers on zero-hours is assumed to be the 
half  of  workers  in  short-time  work  scheme  (based  on  the  number  of 
applications sent up to the beginning of May 2020). 
Source:  Eurostat  and  Staff’s  calculations  based  on  data  collected  from 
national  institutions  and  provided  by  Müller  and  Schulten  (2020), 
“Ensuring  fair  short-time  work  -  a  European  overview  “,  ETUI  Policy 
Brief. 

The euro area is relatively at par with other OECD countries when it comes to product 
market regulation at large, but some barriers persist in services. The euro area fares way 
below the OECD average with regards to the removal of barriers in services (retail trade and 
professional services), while it lags behind the best OECD performers in network industries 
(Graph  20).  Persisting  barriers  have  affected  negatively  intra-EU  trade  flows  both  in  the 
goods and the services sectors.76 At the same time, the catalyst role played by the pandemic 
to boost digital usage is likely to benefit digital services sectors and more largely the digital 
single  market.  The  pandemic,  for  instance,  has  had  a  direct  impact  on  the  euro  mode  of 
payments as it has accelerated the use of digital and cashless payment methods.77 

72 See for instance COM(2020) 575 final, “Annual Sustainable Growth Strategy 2021”. 
73 See for instance COM(2018) 772 final, “The Single Market in a changing world. A unique asset in need of 
renewed political commitment” or London Economics and PwC, (2013), “The cost of non-Europe: the untapped 
potential of the European Single Market”, Final Report, London/Luxembourg. 
74  For  more  details,  see  COM(2020)  93  final,  “Identifying  and  addressing  barriers  to  the  Single  Market”,  22 
November 2018. 
75 For more details, see COM(2020) 94 final, “Long term action plan for better implementation and enforcement 
of single market rules.”, 10 March 2020. 
76 For more details, see SWD (2019) 444 final, “Single Market Performance Report 2019”, 17 December 2019. 
77 See, for instance, Keynote speech by Fabio Panetta, “On the edge of a new frontier: European payments in the 
digital age” 22 October 2020. 

28 

 
 
 
 
                                                 
3.2. Labour markets and social protection 

The COVID-19 crisis has had a major impact on labour markets and social conditions. 
The recent crisis has triggered a reversal of the employment gains experienced over the past 
seven  years  (see  Section  1)  and  contributed  to  further  divergences  in  labour  market 
indicators. The effect on labour markets have been particularly strong for young workers, due 
to their relatively higher representation in sectors more affected by the crisis (e.g., tourism), 
to  the  widespread  presence  of  precarious  forms  of  contracts,  and  difficulties  entering  the 
labour market. The crisis has also particularly hit sectors with a high share of minimum wage 
earners and it is likely to have a stronger impact on disadvantaged workers.78 Measures taken 
by  Member  States79,  among  others,  to  support  job  retention,  protect  incomes  and  provide 
liquidity to affected firms, helped workers and households to cope with the crisis, limiting its 
social consequences and improving the work-life balance in face of mobility restrictions.80,81 
A number of policies  can contribute to  ensuring  that the social,  employment  and  economic 
impact  of  the  crisis  is  mitigated.  The  role  of  social  dialogue  is  key  in  the  design  and 
implementation of these policies, including for minimum wages. 82 

The  extensive  use  of  short-time  work  schemes  has  so  far  contained  the  rise  in 
unemployment that would otherwise have resulted from the sharp economic contraction 
(see  Graph  21  and  comparative  data  in  Section  1).  Building  on  positive  experience  from 
short-time  work  schemes  in  some  countries  during  the  Global  Financial  Crisis,  euro  area 
countries  have  quickly  reacted  by  adjusting  and  expanding  their  schemes,  or  creating  new 
ones.83  Recently,  few  Member  States  have  started  scaling  back  emergency  measures,  while 
others  have  prolonged  or  adapted  them.  These  adaptations  are  meant  to  target  the  relevant 
sectors of the economy without hindering the reallocation of human capital to other sectors of 
the economy with better growth prospects.  Several Member States have adopted measures to 
increase employee retention and support labour demand by expanding hiring incentives.  

78  The  role  of  minimum  wages  in  protecting  low-wage  workers  has  thus  become  increasingly  important.  Cf. 
Commission  proposal  for  a  Directive  of  the  European  Parliament  and  of  the  Council  on  adequate  minimum 
wages in the European Union (COM(2020) 682 final) and Impact Assessment (SWD(2020) 245 final). 
79  Within  the  European  Semester,  the  2020  Country  Specific  Recommendations  and  the  2020  Employment 
Guidelines called on Member States to ensure that the social, employment and economic impact of the COVID-
19 crisis is mitigated. 
80 European Commission. Directorate General for Employment, Social Affairs and Inclusion. “Employment and 
Social Developments in Europe 2020”. (Publications Office 2020).  https://ec.europa.eu/ social/main.jsp?catId= 
738&langId =en&pubId =8342 &furtherPubs=yes. 
81  The  Commission’s  proposal  for  a  Joint  Employment  Report  2021  provides  detailed  evidence  on  recent 
employment and social trends, as well as on measures taken by Member States. 
82 This  has recently been  highlighted in the  Commission proposal for a  Directive of the  European Parliament 
and of the Council on adequate minimum wages in the European Union (COM(2020) 682 final). The proposed 
Directive  aims  among  others  at  strengthening  the  involvement  of  social  partners  in  statutory  minimum  wage 
setting and updating, as well as promoting collective bargaining on wage setting. Moreover, Member States may 
entrust the social partners with the implementation of the proposed Directive. 
83 For earlier studies on the positive effects on variability of employment of short-time work schemes, during the 
Global  Financial  Crisis,  see  Arpaia  et  al  (2010),  “Short  time  working  arrangements  as  response  to  cyclical 
fluctuations”, European Economy, Occasional paper 64 | June 2010. 

29 

 
 
                                                 
Despite  large  improvements  in  participation  rates  and  employment  during  the  pre-
COVID-19  expansion  phase,  labour  markets  in  euro  area  countries  suffer  from  a 
number  of  structural  weaknesses  that  have  been  aggravated  by  the  current  crisis. 
Considerable differences across Member States and categories of workers still persist: gender 
gaps  are  wide,  both  in  terms  of  employment  as  well  as  activity  rates  and  earnings,  with 
women  earning  close  to  15%  less  than  men  in  2018  and  youth  unemployment  remains 
persistently high (at  15.6% in 2019, further reaching 16.5% in Q2-2020)); the share of young 
not in employment, education or training (NEET) remains also persistently high, even though 
it  was  decreasing  at  a  relatively  fast  pace  before  the  crisis.  These  gaps  are  widening  for 
particular segments of the labour force such as the youth  and third-country workers.  In this 
context, the need to tackle a surge in the number of job-seekers and support their reallocation 
across occupations or sectors requires effective labour market policies, as well strengthening 
Public Employment Services (PES) to go beyond traditional ways of working.  

The  crisis  will  have  a  significant  impact  on  social  conditions,  in  particular  for 
vulnerable groups.  Those already vulnerable prior to  the crisis  (such as low paid  workers, 
the low-skilled, workers on temporary contracts, the involuntary part-time and self-employed, 
and migrant workers) are likely to be hit hardest, also now through unequal access to digital 
infrastructure  and  skills.  Some  groups  in  particular  families  with  children,  the  long-term 
unemployed, people with disabilities, migrants and persons  with  a migrant  background and 
Roma are relatively more exposed. While decreasing overall, temporary and involuntary part-
time  jobs  remain  high  in  some  euro  area  countries,  which  contributes  to  entrenched  labour 
market precariousness and, ultimately, higher risks of poverty and social exclusion.  

The COVID-19 crisis is likely to increase inequality in the euro area, following years of 
steady improvement in social conditions and living standards of households.84 By 2019, 
some 7 million fewer people were living at risk of poverty or social exclusion compared with 
the 2012 peak. Real GDP per capita increased in all Member States and disposable income 
inequality  has  been  fairly  stable  on  average,  at  least  until  2018.  However,  inequality  levels 
are different across Member States and their trends have varied over recent years. Moreover, 
in  the  last  decades,  low  wages  have  not  kept  up  with  other  trends  thus  affecting  in-work 
poverty,  wage  inequality,  and  the  capacity  of  low-wage  earners  to  cope  with  economic 
distress.85 Labour related income losses caused by the COVID-19 outbreak, together with the 
difficulty  for  welfare  transfers  to  reach  all  households  promptly,  may  pose  serious  risks  to 
living conditions of low-income households. 

84  For  more  on  the  social  dimension  of  the  impact  of  the  COVID-19  crisis  see  also  the  annual European 
Commission.  Directorate  General  for  Employment,  Social  Affairs  and  Inclusion.  “Employment  and  Social 
Developments in Europe 2020” (Publications Office 2020). 
85 Cf. Impact Assessment accompanying the Commission proposal for a Directive of the European Parliament 
and of the Council on adequate minimum wages in the European Union, SWD(2020) 245 final.  

30 

 
 
 
                                                 
3.3. Labour market skills for the digital and green transitions 

Employment  opportunities  and  working  conditions  are  increasingly  tied  to  workers’ 
skills levels as  measured by degree of education. People with higher degree of education 
tend to have higher activity and employment rates and lower unemployment rates (Graph 22).  
Across the euro area, the unemployment rate is  much higher among low-skilled individuals 
than  among  high  skilled  ones  (13.2%  against  4.8%  in  the  second  quarter  of  2020),  while 
participation  rates  also  correlate  positively  with  skills.  Better  skilled  workers  tend  to  earn 
higher wages, which helps in the light of rising dependency ratios.  

The  COVID-19  crisis  has  highlighted  the  importance  of  skills  and  adaptation  to  new 
challenges.  Workers  constantly  need  new  skills,  including  digital,  to  navigate  the  labour 
market,  to  move  across  sectors  and  tap  job  opportunities.  At  the  same  time,  given  the 
expected  demographic  trends,  as  well  as  the  twin  transitions,  the  euro  area  (and  EU  as  a 
whole) may experience significant skill shortages, which need to be addressed to  ensure the 
necessary labour supply. In addition, with the widespread use of digital technologies across 
all  economic  sectors,  higher  levels  of  digital  skills  related  to  specific  technologies  such  as 
cybersecurity or artificial intelligence will be necessary for professionals in different areas. In 
order to reinforce workforce skills, the European Skills Agenda and the  Communication on 
the European Education Area set a number of actions to be followed and several objectives to 
be fulfilled by 2025, based on well-established quantitative indicators, such as participation in 
learning opportunities, learning experience for unemployed as well as the share of adults with 
basic digital skills.86 The European Commission’s Annual Sustainable Growth Strategy 2021 
called  for  unprecedented  investments  in  re-  and  upskilling  as  one  of  the  seven  ‘European 
flagships’ under the Recovery and Resilience Facility.87 

Significant digital-skill heterogeneity across the euro area, if not properly addressed by 
appropriate policies and investments, risks exacerbating further divergences and labour 
market challenges.88 According to the Digital Economy and Society Index (Graph 23), over 
2019 the EU  countries improved their digital  performance in  general  although the rankings 
differ  amongst  countries  including  for  the  human  capital  dimension.89  Digitalisation  has  a 
distinct impact on labour markets and employment composition, with the risk of worsening 
job polarisation and skills mismatch.90 At the same time, labour supply may benefit from the 
introduction of online learning technologies, and digital platforms that lower barrier to labour 
market  participation.  Digitalisation  also  contributes  to  the  rise  of  new  work  arrangements, 
thus affecting social protection systems.  

86 European Skills Agenda for Sustainable Competitiveness, Social Fairness and Resilience (2020). 
87  The  2021  Annual  Sustainable  Growth  Strategy  put  forward  seven  flagship  initiatives.  Those  flagships 
represent  common  challenges  that  call  for  coordinated  investments  and  reforms.  These  are:  (1) Power  up,  (2) 
Renovate, (3) Recharge and Refuel, (4) Connect,  (5) Modernise, (6) Scale-up, (7) Reskill and upskill. 
88  For  the  green  and  digital  transitions,  more  than  just  digital  skills  are  required.  For  more  details,  see 
Morandini, M. C., et al., “Facing the Digital Transformation: are Digital Skills Enough?”, European Economy, 
Economic Brief n. 054, June 2020. 
89 Digital Economy and Society Index, European Commission Digital Scoreboard 2020. 
90 Petropolus G. et al., “Digitalisation and European welfare states”, Bruegel, Blueprint series 30, 2019. 

31 

 
 
                                                 
Graph 23: The Digital Economy and  
Society Index in the euro area, 2020 
5 Digital Public Services
4 Integration of Digital Technology
3 Use of Internet
2 Human Capital
1 Connectivity

% 

Graph 22: Activity, employment and unemployment 
rates by educational attainment  (2020Q2) 

Less than primary, primary and lower
secondary education
Upper secondary and post-secondary non-
tertiary education
Tertiary education

100

% 

80

60

40

20

0

80

70

60

50

40

30

20

10

0

Activity

Employment

Unemployment

I
F

L
N

T
M

E
I

E
E

E
B

U
L

S
E

E
D

T
A

T
L

R
F

I
S

V
L

T
P

K
S

Y
C

T
I

L
E

Note:  Latest  available  quarters  are  2020Q2  (activity  and  unemployment)  and 
2019Q4 (employment). The activity  rate  is the ratio between the  number of active 
persons  (occupied  labour  force  and  the  unemployed)  and  the  corresponding  total 
population. 
Source: Eurostat. 

Note: The DESI2020 ranking  is calculated based on EU 28 Member States; in the 
chart, only the results of euro area countries are included. 
Source: European Commission. 

The  green  transition  is  also  an  increasingly  important  driver  of  labour  demand  and 
skills supply across all sectors, as the shift implies structural changes across sectors and 
occupations.  While  the  impact  of  the  greening  of  the  economy  and  employment  can  be 
expected  to  take  the  form  of  new  green  skills  within  existing  occupations  as  well  as  the 
creation  of  new  jobs91  in  areas  such  as  clean  energy,  there  is  still  lack  of  capacity  and 
investments in green skills.92 At the same time, the green transition is expected to have socio-
economic  consequences  for  workers  employed  in  transition  industries,  which  may  need  re-
skilling and up-skilling. The Commission initiatives like the Just Transition Mechanism aim 
to help address these needs. 

3.4. Insolvency frameworks 

Non-bank insolvency frameworks are important for euro area Member States resilience 
to shock and to improve risk-sharing within the union. The next phase of the crisis might 
feature an increase in bankruptcy rates, so it is important that Member States have efficient 
insolvency  frameworks  in  place,  supporting  bank  lending  and  economic  recoveries  while 
reducing the building-up of non-performing loans (NPLs).93 This is particularly important in 
a currency union, where the flow of credit within countries and across borders might be more 
difficult in the absence of other adjustment mechanisms. 

General insolvency frameworks differ substantially across countries. Even though based 
on simplifying assumptions and containing some element of appraisal, World Bank indicators 
(Graph  24)  point  to  considerable  variations  across  the  euro  area  in  terms  of  length  of 
corporate insolvency proceedings, their cost and outcomes (recovery rates for creditors). The 

91 Skills for green jobs: 2018 update. European synthesis report. 
92  European  Skills  Agenda  for  Sustainable  Competitiveness,  Social  Fairness  and  Resilience  includes  specific 
actions to support the twin transition. 
93 Ari, A., Chen, S. and Ratnovski, R., “COVID-19 and non-performing loans: lessons from past crises”, ECB 
Research 
https://www.ecb.europa.eu/pub/economic-
research/resbull/2020/html/ecb.rb200527~3fe177d27d.en.html. 

27  May 

Bulletin 

2020 

71, 

No 

32 

 
 
 
 
                                                 
insolvency  frameworks  differ  as  a  result  of  distinct  societal  considerations,  legal  traditions 
and financial systems. Although there is no single prescription, a number of broad principles 
identified in the legal and economic literature94 have been translated into best practices.95  

Graph 24: Efficiency of insolvency frameworks  
in the euro area 

Graph 25: Government Effectiveness, euro 
area and OECD high-income countries, 2019 

100
90
80
70
60
50
40
30
20
10
0

Eurcents on 
the euro 

Recovery rate (LHS)

Years 

Time (RHS)

100

Rank 

90

80

70

60

50

40

30

20

10

0

4,5

4,0

3,5

3,0

2,5

2,0

1,5

1,0

0,5

0,0

Source: World Bank Doing Business. 

Source: Worldwide Governance Indicators, World Bank. 

The divergence of insolvency frameworks remains an obstacle for cross-border capital 
flows.  Differences  in  insolvency  proceedings  contribute  to  a  home  bias,  as  investors  shy 
away  from  legal  risks  and  costs  linked  to  possible  restructuring/insolvency  proceedings 
abroad.  Cross-border  insolvency  proceedings  are  often  inefficient,  complex,  and  expensive, 
especially  for  SMEs.  It  takes  about  two  years  on  average,  with  considerable  variations 
between jurisdictions, to resolve a domestic insolvency in the EU. Cross- border proceedings 
take three years on average and are twice as expensive.96 

The  impact  of  the  COVID-19  crisis  may  in  some  countries  lead  to  an  increase  in 
in  some  cases  require  an  adaptation  of  insolvency 
bankruptcies,  which  may 
frameworks. Despite exceptional measures to contain the impact of the crisis on firms and 
households,  corporate  bankruptcies  are  likely  to  increase  in  the  coming  years  in  light  of  a 
protracted  reduction  in  business  activity  and  profitability.  The  repayment  capacity  of 
households  will  also  be  under  strain,  due  to  increased  joblessness  and  reduced  income 
prospects.  The  increase  in  debt  distress  may  in  some  cases  put  a  strain  on  insolvency 
frameworks  in  terms  of  court  congestion  and  a  slower  than  needed  workout  of  bad  debt  in 
bank  balance  sheets.  In  this  context,  insolvency  frameworks  will  play  a  crucial  role  in  the 

94 See, for instance, Djankov, S., O. Hart, C. McLiesh, and A. Shleifer, "Debt Enforcement around the World", 
Journal of Political Economy, vol. 116, no. 6, 1105-1149, 2008; La Porta, R.., Lopez-de-Silanes F., Shleifer A., 
and Vishny, R. W. , “Legal Determinants of External Finance”, Journal of Finance, vol. 52(3), pp 1131-50, July 
1997: Bricongne et al. “Macroeconomic Relevance of Insolvency Frameworks in a High-debt Context: An EU 
Perspective," European Economy - Discussion Papers no. 32, 2016. 
95 The Eurogroup identified a number of principles including early identification of debt distress and availability 
of early restructuring procedures. See https://www.consilium.europa.eu/en/meetings/eurogroup/2016/04/22/ . 
96 European Commission, Early restructuring and a second chance for entrepreneurs: A modern and streamlined 
approach 
June  2019,  https://ec.europa.eu/info/sites/info/files/factsheet_-_a_ 
insolvency, 
modern_and_streamlined_approach_to_business_insolvency.pdf . 

to  business 

33 

 
 
 
 
                                                 
process  of  supporting  viable  firms  undergoing  temporary  problems  and  providing  for  the 
orderly exit of non-viable firms. 

The European Commission has emphasised the need for insolvency framework reforms 
in economic surveillance, and has taken several initiatives to foster best practices.97 

 

 

In 2019, the Restructuring and Second Chance Directive was adopted to promote 
early restructuring and a second chance for entrepreneurs.98 The aim of the directive is 
to  introduce  minimum  standards  among  EU  Member  States  for  preventive 
restructuring  frameworks  available  to  debtors  in  financial  difficulty  and  for 
procedures leading to a discharge of debts incurred by over-indebted entrepreneurs, as 
well  as  to  provide  measures  to  increase  the  efficiency  of  all  types  of  insolvency 
procedures. 
In the new action  plan on Capital Markets Union, the European Commission has 
announced  measures  to  make  the  outcome  of  cross  border  investment  more 
predictable  as  regard  insolvency  proceedings.  Bearing  in  mind  that  different 
institutional settings – which do not only pertain specifically to insolvency regulation 
(e.g.  efficiency  of  judicial  systems  or  foreclosure  legislation)  –  affect  insolvency 
outcomes, harmonisation of certain targeted areas of national insolvency rules or their 
convergence  could  enhance  legal  and  financial  certainty,  as  well  as  would  facilitate 
cross-border  financial  operations  in  European  capital  markets.  The  European 
Commission  will  take  a  legislative  or  non-legislative  initiative  for  minimum 
harmonisation  or  increased  convergence  in  targeted  areas  of  core  non-bank 
insolvency. The plan also foresees regular monitoring of the effectiveness of national 
loan enforcement regimes through enhanced data reporting that would allow Member 
States  to  benchmark  their  insolvency  regimes  against  those  in  other  Member  States 
and encourage a strengthening of their regimes.  

  The  European  Commission  will  publish  a  Communication  outlining  actions  that 
could be taken at the current juncture, in order to address possibly rising NPLs, with a 
focus  on  developing  secondary  markets  for  distressed  assets  and  reforms  of 
insolvency and debt recovery frameworks.  

3.5. Administrative and absorption capacity and other drivers of institutional quality 

The issue of administrative quality will be all the more important as the amount of EU 
funding some of the euro area Member States will have  to absorb in the coming years 

97  The  economic  literature  offers  a  number  of  principles  to  increase  the  efficiency  of  non-bank  insolvency 
frameworks.  Insolvency  framework  should  ensure  an  equitable  treatment  of  creditors  on  the  one  hand,  and  a 
maximisation of the value of the debtor’s assets on the other, including the option to liquidate assets as a going 
concern.  It  should  ensure  the  continuity  of  the  economic  activity  through  restructuring  when  it  is  possible.  It 
should  not  dissuade  risk-taking  and  entrepreneurship  while  protecting  creditors  against  dishonest  behaviours, 
including strategic default. Predictability and effectiveness  of proceedings are also key to attract investors  for 
distressed securities and boost the secondary markets for NPLs. 
98  Directive  (EU)  2019/1023  of  the  European  Parliament  and  of  the  Council  of  20  June  2019  on  preventive 
restructuring frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency 
of  procedures  concerning  restructuring,  insolvency  and  discharge  of  debt,  and  amending  Directive  (EU) 
2017/1132 (Directive on Restructuring and Insolvency). OJ L 172, 26.6.2019. 

34 

 
 
                                                 
will be large. The EU grants for investments and reforms available in the next few years will 
include  the  European  Structural  and  Investment  Funds  and  Next  Generation  EU  (including 
high  amounts  of  Resilience  and  Recovery  Facility  grants).  For  some  euro  area  Member 
States, notably Greece, Slovakia, Latvia, Lithuania, Estonia and Portugal, the sum of all these 
funds may well represent more than 2% of GDP in annualised terms. Administratively, this 
will require careful planning and implementation to ensure that EU outlays are efficiently and 
timely spent on the ground and in line with a coherent  economic, social and environmental 
strategy. 

More  broadly,  sound  institutions  and  economic  structures  can  enhance  economic 
resilience  and  long-term  growth  in  the  euro  area.  Most  Member  States  are  still  lagging 
behind considerably the best performing countries of the OECD, over the quality of national 
institutions and the efficiency of economic structures.99 In terms of government effectiveness, 
while a number of euro area countries are among the worldwide best performers, the majority 
score  worse  than  the  average  of  high-income  OECD  countries  (Graph  25).  Against  this 
backdrop, there is a large body of economic literature showing that differences in institutions 
across countries contribute to cross-country differences in income per capita.100  

Strengthening  institutional  quality  at  national  level  can  improve  the  delivery  of 
structural  reforms  in  the  euro  area.101  There  is  evidence  that  measures  that  improve  the 
institutional framework bring particularly strong long-term benefits and are a prerequisite for 
reforms  in  other  areas  to  be  effectively  implemented.  High-quality  institutions,  particularly 
those  that  ensure  the  efficient  and  impartial  functioning  of  public  administration  including 
insolvency  frameworks,  effective  justice  systems  and  a  high  degree  of  transparency  and 
accountability,  are  also  a  prerequisite  for  reforms  in  other  areas  (in  particular  market 
regulation) to be effectively implemented and yield their full potential. 102 

Selected features of public administrations and governance play an important role for 
investments.103  Cumbersome  bureaucracies  may  delay  the  distribution  of  permits  and 
licenses, thus slowing down investments. Second, corruption, or perception thereof is found 
to  negatively impact  the investment  climate and on economic growth.104  Corruption creates 
uncertainty  and  it  is  effectively  an  added  “cost”,  which  hampers  the  optimal  allocation  of 
resources.105  In  the  euro  area,  there  is  a  positive  (unconditional)  correlation  between  a 

99 “Increasing resilience and long-term growth: the importance of sound institutions and economic structures for 
euro area countries and EMU”, ECB Economic Bulletin, Issue 5, 2016. 
100 The term institution is construed broadly, to cover a variety of aspects, such as the enforcement of property 
rights (North, 1973), the rule of law including the system of checks and balances on the executive power (Levy, 
2007) and the existence of an efficient public sector (World Competitiveness report, 2015). 
101 See 2021 Annual Sustainable Growth Strategy (2020). 
102 Thorough the new Technical Support Instrument, the European Commission will support Member States in 
developing  and  implementing  a  coherent  set  of  reforms  to  support  the  recovery  and  consolidate  strong,  long 
term  growth.  See  https://www.consilium.europa.eu/en/press/press-releases/2020/07/22/council-agrees-its-
position-on-an-instrument-to-support-implementation-of-reforms-for-a-sustainable-recovery/. 
103 Investment is construed broadly, to include both tangible and intangible assets (e.g., human capital). 
104 See for example Mauro (1995) who concludes that corruption is found to lower investment, thereby lowering 
economic growth. 
105 See Global Competitiveness Report (2015-2016) and references therein. 

35 

 
 
                                                 
measure of the quality of public administration and the ratio of gross fixed capital formation 
to  GDP  (Graph  26a).  In  addition,  investment  appears  to  be  also  negatively  correlated  with 
people’s perceptions of corruption (Graph 26b) and with business’ perceived complexity of 
administrative procedures (Graph 26c).106 Improving the governance structure and building-
up  the  necessary  administrative  capacity  are  crucial  to  provide  a  regulatory  environment 
conducive to investment. Planning and implementing ambitious investment projects including 
for the achievement of the green and digital transitions requires specific skills, including the 
ability 
technological 
developments.  

to  plan  and  execute  strategic 

investments 

to  steer 

long-run 

Graph 26: Relationship between investment and quality of public administration (a), perceived 
corruption (b) and perceived complexity of administrative procedures (c). EU28 and EA19 countries 

26. a) Investment and quality of public 
administration 

26. b) Investment and perceived corruption 

26. c) Investment and perceived 
complexity of administrative procedures 

Source: European Commission.  
Notes:   Average  gross  fixed  capital  formation  to  GDP  ratio  over  2010-2019;  EU28  and  Euro  area-19  countries.  PAC:  European  Commission’s  public 
administration composite index, based on (OECD SIGMA, 2017); Average of 2017 and 2019 values. The perception of corruption indicator is taken from the 
Special  EuroBarometer  on  corruption  numbers  79.1,  88.2  and  92.4;  The  complexity  of  administrative  procedures  indicator  is  taken  from  the  Flash 
Eurobarometer numbers 428, 457 and 482. 

3.6. Risks of macroeconomic imbalances 

The COVID-19 crisis could further exacerbate existing imbalances across the euro. The 
impact of the pandemic and the associated recession has generally been stronger in countries 
already characterised by large stocks of private or public debt (Graph 27). The major drop in 
incomes in 2020 is expected to be only partially offset in the subsequent years, with nominal 
GDP remaining below levels observed before the COVID crisis. This automatically implies 
growing  debt-GDP  ratios.  Both  private  and  public  debts  will  also  grow  because  of  missing 
revenues  and  increased  borrowing  needed  by  corporations  and  the  public  sector  to  cushion 
the  recession.  Although  the  dynamic  of  household  debt  shows  a  relatively  contained 
development,  corporate  debt  is  expected  to  increase  considerably  across  the  board  in  2020, 
also on account of liquidity needs.107  

106 The EIB investment report 2019-2020 highlights that lack of administrative capacity is a  major investment 
barrier. See https://www.eib.org/en/publications/investment-report-2019. 
107 On this issue, see 2021 Alert Mechanism Report (2020). 

36 

 
 
 
 
 
 
                                                 
The  COVID-19  outbreak  is  likely  to  have  a  negative  impact  on  income  prospects  for 
households and corporations, and could translate into debt distress as well as a higher 
share  of  non-performing  loans.  The  ensuing  deterioration  of  bank  balance  sheets  could 
compound the narrow profitability margins in the banking sectors constraining lending to the 
real  economy,  which  in  turn  could  adversely  affect  GDP  growth,  amplifying  the  initial 
problems with  NPLs  (See also  4.1). Furthermore,  in  a deeply  economically-integrated area, 
elevated NPL ratios may pose cross-borders risks. Market tensions in one country are likely 
to constrain credit supply and economic growth in the euro area as a whole. These imbalances 
can  hinder  the  smooth  functioning  of  EMU  if  not  properly  addressed.  Finally,  housing 
markets  also  pose  a  risk  going  forward  following  a  sustained  increase  in  house  prices  – 
including evidence of overvaluation – in many Member States which may lead to downward 
corrections on the back of falling labour incomes. These downward corrections, especially if 
taking  place  in  a  disorderly  fashion,  may  affect  collateral  valuation  and  therefore  bank 
balance sheets distress.108 

Graph 27: Recessions, COVID-19 death toll, and 
debt 

Graph 28: Net international investment positions 
(NIIP) 2018-2021 and benchmarks in 2019 

Source: Eurostat, ECDC for COVID-19 deaths 

Source: Eurostat and Commission services calculations.  
Note:  NIIP  in  line  with  fundamentals  (NIIP  norms)  are  obtained  as  the 
cumulation over time of current account norms. NIIP prudential thresholds are 
determined from the maximisation of the signal power in predicting a balance 
information 
of  payment  crisis, 
summarised by per-capita income.  

into  account  country-specific 

taking 

In a number of countries, Net International Investment Positions (NIIPs) remain large 
and  negative  and  the  COVID-19  crisis  is  likely  to  halt  improvements  in  recent  years 
(Graph 28). In countries such as Cyprus, Greece, Ireland, and Portugal, NIIPs are beyond the 
NIIP  norms  and  respective  prudential  threshold.  These  four  countries,  together  with  Spain, 
show  a  strong  incidence  of  debt  liabilities  in  their  NIIPs  and  in  2020,  the  expected  strong 
decline  in  GDP  will  negatively  affect  their  NIIP-to-GDP  ratio.109  Moreover,  countries  with 
larger stocks of net external liabilities are more dependent on sectors highly impacted by the 
crisis, notably tourism. 

108 Although house price growth remained rather sustained (including in early 2020), quarterly data, estimates of 
price  levels  from  quotations  by  sellers  and  model-based  house  price  forecasts  point  to  a  softening  of  housing 
markets. For more details, see 2021 Alert Mechanism Report (2020). 
109 On this issue, see 2021 Alert Mechanism Report (2020). 

37 

BEBGCZDKDEEEIEELESFRHRITCYLVLTLUHUMTNLATPLPTROSISKFISE-4-3-2-101101001000GDP, average 2020-21 % changeCOVID-19 deaths per millionSum of public and private debt (% of 2019 GDP)-180-150-120-90-60-300306090120NLDKDELUMTBESEATFIITSICZEEFRLTBGLVROHUPLHRSKESPTCYELIE% of GDPNIIP 2018NIIP 2019NIIP 2020fNIIP 2021fNENDI 2019Prudential NIIP threshold 2019NIIP norm 2019 
 
 
 
 
 
                                                 
4.  Macro-financial Stability 

4.1. Financial market developments 

The economic and financial implications of the pandemic and subsequent containment 
measures have been muted, following some initial financial market stress. The worsening 
macroeconomic and earnings outlook led to sharp price corrections in February-March 2020, 
which  were  widespread  across  regions  and  asset  classes  and  were  accompanied  by  sharp 
increases  of  market  volatility  (Graph  29).  Concomitant  to  the  rapid  market  sell-off,  market 
financing  conditions  tightened  as  credit  risk  premia  increased,  with  euro  area  non-financial 
corporates’ investment grade bond yields edging up in April to their highest levels since early 
2014. The deterioration in corporate bond market liquidity was particularly pronounced in the 
high-yield  segment,  as  mirrored  in  a  sharp  increase  in  bid-ask  spreads  to  levels  above  the 
peak  of  the  Global  Financial  Crisis.  At  the  same  time,  liquidity  conditions  deteriorated  in 
many market segments  amid a general flight to liquidity, which initially also affected high-
quality  asset  markets.110  In  subsequent  months,  market  conditions  have  eased  and  stock 
markets  have  recovered  much  of  the  initial  losses,  fueled  by  decisive  governmental  and 
central bank action.  

Graph 29: Systemic stress in the euro area 

Graph 30: Bank stability indicators 

0,8

0,6

0,4

0,2

0
2011

Composite indicator of systemic stress
(daily)
Composite indicator of systemic stress
(weekly)
Composite indicator of systemic stress in
sovereign bond markets (monthly)

20

19

18

17

16

15

14

13

12

11

10

% 

% 

CET 1 ratio (lhs)

Leverage ratio (lhs)

NPL ratio (rhs)

9

8

7

6

5

4

3

2

1

0

2012

2014

2015

2017

2018

2020

2015

2016

2017

2018

2019

2020

Note (Graph 26): Domestic banking groups and stand-alone banks, foreign (EU and non-EU) controlled subsidiaries and foreign (EU and non-EU) controlled 
branches, All institutions. 
Source: ECB – CISS database (Graph 25), ECB - CBD2 - Consolidated Banking data (Graph 26). 

Euro area banks entered the current crisis with stronger capital levels, better liquidity 
positions and more stable funding structures compared to the onset of the 2008 Global 
Financial  Crisis,  increasing  their  capacity  to  absorb  potential  losses  and  to  maintain 
lending.  Euro  area  banks’  CET1-ratios  further  strengthened  to  14.8%  at  the  end  of  2019, 
which was mainly achieved via retained earnings (Graph 30). Euro area banks’ holdings of 
High Quality Liquid Assets (HQLA) also increased significantly over the past years, mainly 

110 For instance, the bid-ask spread for German Bunds more than doubled in March and April,  albeit from low 
levels, while sovereign bond spreads in the euro area increased significantly. At the same time, the Euribor 3m 
spread over Eonia increased substantially. 

38 

 
 
                                                 
 
 
on  account  of  larger  central  bank  reserve  holdings  following  the  Eurosystem’s  asset 
purchases.  Meanwhile, euro area banks continued their steady reduction of non-performing 
loans (NPL) even through the very early stage of the pandemic, with the euro area NPL ratio 
declining  to  its  lowest  level  at  2.9%  in  Q1  2020,  compared  to  3.6%  at  the  end  of  2018.111 
Some national  NPL ratios still remain far apart  from  the euro area  average  and continue to 
require  attention.  NPL  volumes  are  likely  to  increase  substantially  as  a  result  of  the 
coronavirus  outbreak,  in  particular  in  the  Member  States  and    for  loans  to  sectors  most 
affected  by  the  pandemic.  However,  given  the  various  government  guarantee  schemes  and 
debt  moratoria  in  combination  with  the  recently  announced  SSM  flexibility  regarding  the 
supervisory treatment of NPLs112, such an increase could come with some delay. 

The crisis is expected to put further pressure on banks’ already low profitability levels. 
With  the  pandemic  outbreak,  euro  area  bank  valuations  saw  strong  downward  pressure  in 
anticipation  of  the  pandemic’s  effect  on  banks’  balance  sheets  and  their  expected 
profitability113  (Graph  31).  This  might  impact  their  intermediation  capacity  going  forward, 
which is important to maintain in order to support the recovery. On the funding side, banks’ 
bond  funding  costs  increased  at  the  outset  of  the  pandemic,  in  particular  for  riskier 
instruments  such as unsecured  and contingent  convertible bonds, but  have moderated again 
somewhat  in  subsequent  months.  Both  unsecured  and  secured  interbank  markets  overall 
showed resilience during the market turbulences, in particular when compared to the Global 
Financial Crisis. Swift and sizeable central bank interventions such as additional refinancing 
operations and net asset purchases significantly contributed to that. Consequently, short-term 
funding remained ample for euro area banks and private sector deposits continue to provide 
euro area banks with a stable and abundant source of funding.114  

Non-financial corporations’ credit demand surged in the first half of 2020 in the face of 
mounting  liquidity  shortages,  while  banks  have  so  far  kept  their  credit  standards 
largely  unchanged.115  Ample  central  bank  liquidity  provision,  as  well  as  fiscal  measures 
such  as  government  guarantees,  allowed  banks  so  far  to  satisfy  the  growing  credit  demand 
while  maintaining  overall  favourable  lending  conditions.  Consequently,  the  annual  growth 

111 Faster corrections were observed in Member States with the highest stock of such loans. In Greece, the NPL 
ratio  has  decreased  but  it  still  remains  the  highest  across  the  euro  area,  around  35%.  Similarly,  Cyprus  has 
recorded notable improvements that translated into its NPL ratio falling below 20%, In Italy and Portugal the 
NPL ratio has declined markedly in the last years with moderate reductions in 2019, to below 7%. On this see 
also the 2021 Alert Mechanism Report (2020).   
112 The Single Supervisory Mechanism (SSM) announced on 20 March would exercise flexibility regarding the 
classification  of  debtors  as  “unlikely  to  pay”  when  banks  call  on  public  guarantees  granted  in  the  context  of 
coronavirus. Furthermore, a flexible approach would be applied regarding loans under COVID-19 related public 
moratoriums.  
113 Quarterly data for EU-banks under SSM supervision show a steep decline in those banks’ return on equity in 
the first half of the year 2020, reaching 0.01% in the second quarter. 
114  In  some  euro  area  countries,  interest  rates  on  corporate  deposits  have  entered  negative  territory,  thus 
supporting banks’ net interest margin in an environment of fluctuating asset prices. 
115  While  the  second  quarter  saw  a  considerable  loosening  of  credit  standards  on  corporate  loans  in  the  euro 
area, during the third quarter the opposite direction of standards led to overall unchanged results over the course 
of the year. 

39 

 
 
                                                 
rate  of  loans116  to  non-financial  corporations  increased  sharply  from  March  on  (Graph  32), 
despite  many  firms  postponing  larger  investment  projects,  as  corporates  substantially 
increased their demand for short-term loans and drew on existing credit lines in the face of 
liquidity shortages and the precautionary build-up of liquidity buffers. Corporates’ net long-
term  bond  issuance  surged  between  April  and  June,  almost  exclusively  as  a  result  of 
investment-grade issuance.  

Graph 31: Banks’ return on equity 

Graph 32:  Loans to the private non-financial 
sector*, euro area 

EA19*

SSM banks**

% 

Estimated long-run cost of equity*** 

Non-financial corporations

Households

% 

8

7

6

5

4

3

2

1

2008 2010 2012 2014 2016 2018 2020

0
2016

2017

2018

2019

2020

12

10

8

6

4

2

0

-2

-4

Note: *Domestic banking groups and stand-alone banks. **Single 
Supervisory Mechanism (SSM) Banks quarterly data have been aggregated 
on a yearly average. The data-point related to 2020 corresponds to the 
average of 2020Q1 and 2020Q2. ***Required RoE as self-reported by 
banks in the semi-annual Risk Assessment Questionnaire of the EBA, 
Spring 2020. 
Source: ECB. 

Note: *Annual growth rates, loans adjusted for sales and securitisation as well as 
for positions arising from notional cash pooling services provided by MFIs. 
Source: ECB. 

Some  parts  of  the  non-bank  financial  sector  experienced  valuation  losses  and  large 
outflows, which have been only partly recovered. The substantial market re-pricing at the 
onset of the corona crisis, which was particularly pronounced in the high-yield segment, led 
to  significant  valuation  losses  also  for  non-banks.  Subsequently,  investment  and  money 
market funds experienced large outflows in a relatively short period amid a general flight to 
safety, squeezing liquidity and threatening the short-term funding.117 ECB interventions such 
as the PEPP announcement, but also the inclusion of non-financial commercial paper in the 
list  of  eligible  assets  under  its  Corporate  Sector  Purchase  Programme  (CSPP),  stabilized 
markets and led to some recovery in non-banks’ valuations. Euro area insurers and pension 
funds were initially less affected by valuation losses due to their comparatively conservative 
portfolio mixes. However, given their already strained profitability situation, the combination 
of  falling  asset  prices  and  the  prospect  of  an  even  longer  period  of  very  low  interest  rates 
poses a challenge going ahead. 

116 Adjusted for sales and securitisation and the impact of notional cash pooling. 
117  Between  12-18  March,  outflows  from  euro  area  money  market  funds  were  the  second  highest  on  record, 
surpassed only in September 2008. 

40 

 
 
                                                 
      
 
 
4.2. Risks to macro-financial stability 

Euro  area  banks  have  withstood  the  first  wave  of  the  pandemic  shock,  but  its  full 
impact  is  still  uncertain.118  A  recent  ECB  vulnerability  analysis  of  banks  under  SSM 
supervision suggests that the euro  area banking sector is  capable of withstanding the initial 
pandemic-induced  stress.119  However,  a  worsening  of  the  economic  situation  would  impact 
banks’ capital position more severely. Specifically, under the baseline scenario (i.e. real GDP 
shrinking by 8.7% in 2020), banks’ CET1 ratio would be around 1.9 percentage points lower 
by the end of 2022, whereas under a more severe scenario (i.e. real GDP shrinking by 12.6% 
in 2020) it would shrink by 5.7 percentage points. For orientation, the Commission’s Autumn 
forecast  estimates  real  GDP  in  the  euro  area  to  contract  by  7.8%  in  2020,  however,  these 
estimates are surrounded by significant downside risks.  

Prolonged  government  loan  guarantee  schemes  could  protect  the  banking  sector,  but 
also represent contingent liabilities for Member States’ budgets. While general support to 
the private sector during the pandemic and loan guarantees, in particular, are helping solvent 
firms and households stay liquid in times of market stress, a substantial amount of defaults is 
still to be expected as a result of the pandemic.120 Whether and when these defaults on loans 
show up on banks’ balance sheets will to some extent depend on the overall duration of these 
guarantees. While an early end obviously risks substantially increasing NPL ratios and tighter 
credit  conditions121,  the  guarantees  might  be  increasingly  activated  if  those  schemes  persist 
for some time, thereby effectively weighing on government debt. Higher sovereign debt as a 
result  of  realized  loan  losses  covered  by  guarantees  in  turn  could  reignite  market  concerns 
about  public  debt  sustainability  in  some  Member  States,  with  negative  effects  on  those 
countries’ financial sector and real economy. Furthermore, given the high concentration and 
home  bias  of  sovereign  debt  in  banks’,  insurers’  and  pension  funds’  portfolios,  solvency 
ratios of euro area financial institutions could also be adversely affected.  

The non-bank financial sector’s exposure  to corporate bonds  makes  it vulnerable to a 
deterioration of corporate sector solvency, which in turn could hinder market access in 
particular  for  riskier  borrowers.  The  financial  sector  could  see  further  valuation  losses 
following  corporate  rating  downgrades,  which  might  come  with  some  delay  (see  above). 
Non-banks, in particular, have large exposures to corporate bonds, including high-yield bonds 
and those that narrowly fulfil investment grade status (BBB) and would thus be particularly 

118 In a typical recession, the decline in corporate fundamentals takes up to three years to translate into higher 
bank NPLs (see the box entitled “Do corporate fundamentals explain differences in sectoral NPLs?”, Financial 
Stability Review, ECB, May 2019). 
119  ECB  Banking  Supervision,  results  overview  of  “COVID-19  Vulnerability  Analysis”,  28  July  2020, 
https://www.bankingsupervision.europa.eu/press/pr/date/2020/html/ssm.pr200728_annex~d36d893ca2.en.pdf  
120 Moreover, a worsening of corporates’ financial conditions interacts closely with households’ ability to repay 
debts, which in turn could reinforce growth of banks’ non-performing assets. 
121  Indeed,  according  to  the  2020Q2  ECB  Bank  Lending  Survey,  banks  expect  their  credit  standards  for  non-
financial  corporations  to  tighten  considerably  in  the  third  quarter,  closely  connected  to  their  expectations  of 
expiring state guarantee schemes for loans in some large euro area countries. 

41 

 
 
                                                 
affected by downgrades.122 If such a downgrade were to trigger further rebalancing towards 
safer  and  more  liquid  assets,  it  would  drive  up market  financing  costs,  in  particular  for  the 
most  vulnerable  and  leveraged  borrowers,  and  might  impair  their  market  access.  Indeed, 
since February, non-financial corporations’ issuance of high  yield bonds has stagnated after 
strong increases over recent years, while investment grade bond issuance surged since April 
in  the  context  of  ECB  monetary  policy  decisions.  However,  disruptions  in  high-yield 
corporate bond markets  can easily spillover to other market segments and adversely impact 
market financing conditions for the whole corporate sector.  

A prolongation of insolvency moratoria  and continued forbearance of non-performing 
loans  entails  difficult  decisions.  While  insolvency  moratoria  can  prevent  immediate  and 
large-scale  bankruptcies  by  giving  vulnerable  corporations  and  households  some  time  to 
benefit from the recovery, they also come with risks, in particular if these schemes persist for 
an extended period of time and the economic recovery is weaker than expected. Non-viable 
businesses  under  solvency  pressures  might  be  incentivized  to  take  more  risks,  potentially 
making the eventual losses under bankruptcy  worse. This  in turn could  undermine business 
confidence  ex-ante  and  also  impact  credit  provision  to  healthy  firms.  Lastly,  delayed 
bankruptcies as a result of loan repayment moratoria could lead to a misallocation of funds to 
non-viable borrowers. Against this background, the Commission has welcomed a list of ‘best 
practices', agreed by the financial sector and consumer and business organisations, which also 
covers payment moratoria and credit guarantees.123   

5.  The EU recovery plan: its impact on EMU and the international role of the euro 

The EU recovery plan, Next Generation EU, beyond its short-term stabilisation function 
and  its  role  in  supporting  the  recovery  post-crisis,  has  the  potential  to  permanently 
change the EMU.  The collective action taken at the EU level has reassured markets and the 
policies are likely to increase the euro area’s growth potential and resilience to future shocks. 
With  a  significant  portion  of  the  debt  issuance  as  green  bonds,  the  recovery  plan  has  the 
potential  to  accelerate  the  EU’s  decarbonisation  and  clean  energy  transition.  Finally,  given 
the  increase  in  the  issuance  of  high-quality,  euro-denominated  debt,  the  recovery  plan  can 
strengthen  the  euro’s  role  as  an  international  reserve  currency  particularly  if  coupled  with 
ambitious EMU reforms.  

5.1. Impact of the European recovery plan on the international role of the euro  

The international role of the euro has remained broadly stable in recent years. The euro 
is the number two currency in the world although, contrary to the US dollar, with a largely  

122 According to the ECB, at the end of 2019, euro area non-bank financial institutions (including MMFs) held 
around EUR 330 billion of high-yield and non-rated and around EUR 280 billion of BBB-rated debt securities 
issued  by  euro  area  NFCs,  whereas  euro  area  banks  held  around  EUR  40  billion  and  EUR  30  billion, 
respectively.  Euro  area  non-banks  also  held  around  EUR  240  billion  of  debt  issued  by  NFCs  belonging  to 
sectors particularly badly hit by the coronavirus-related restrictions.  
123See  https://ec.europa.eu/info/sites/info/files/business_economy_euro/banking_and_finance/documents/00714 
-best-practices-mitigate-impact-pandemic_en.pdf. 

42 

 
 
                                                 
Graph 33: Euro denominated share of foreign 
exchange reserves, international debt securities 
and cross-border loans 

Graph 34: Current and projected AAA-rated  
euro area government debt and recovery 
package issuance 

% of total 

Foreign Exchange Reserves
International Debt Securities
Cross-border loans

70

60

50

40

30

20

10

0
2000 2003 2006 2009 2012 2015 2018

Source: IMF Database, BIS Database. Own computations. 

EUR trn 

AAA EA governent debt

NGEU/SURE issuance

5

4

3

2

1

0

2015 2016 2017 2018 2019 2020 2026
Note: Unless  indicated otherwise, the data presents outstanding amounts at 
the end of the year. For the projections, countries considered rated AAA are 
those rated at this grade in Q2 2020 (i.e. DE, LU and NL). 
Source: Bloomberg, Commission services. 

regional  character.  The  latest  assessment  by  the  ECB  covering  2019  shows  that  the  euro’s 
share in outstanding international loans increased while the share of the euro in outstanding 
international  debt  securities  declined  compared  to  2018.124  The  share  of  the  euro  in  global 
foreign exchange reserves (Graph 33) and in outstanding international deposits as well as the 
use of the euro as an invoicing currency for extra-euro area transactions in goods remained 
broadly  stable.  Likewise,  the  stock  of  euro  banknotes  circulating  outside  the  euro  area 
remained largely unchanged. Strengthening the economic and financial autonomy of the EU 
including  through  an  enhanced  international  role  of  the  euro  is  part  of  the  Commission’s 
agenda125,  and  a  Communication  in  this  regard  will  be  released  shortly  as  indicated  in  the 
Commission’s revised work program.  

The common response by the EU to the crisis has increased the overall resilience of all 
Member  States  including  those  in  the  euro  area  and  provided  strong  reassurances  to 
markets. Overall, credit rating agencies have identified the Next Generation EU agreement 
as  a  net  supportive  factor  of  Member  States’  sovereign  ratings.126  On  top  of  its 
macroeconomic effects, the sizeable issuance of safe, euro-denominated debt resulting from 
the  recovery  package  can  be  an  important  contributing  factor  towards  further  financial 
markets  development  and  integration.  For  example,  as  banks  complement  domestic 
government bond holdings with EU debt, it could facilitate portfolio diversification and help 

for 

example,  Political  guidelines 

124  European  Central  Bank.  “The  international  role  of  the  euro”,  June  2020,  https://www.ecb.europa.eu/pub 
/ire/html/ecb.ire202006~81495c263a.en.html. 
125  See, 
https://ec.europa.eu/commission/sites/beta-political/files/political-guidelines-next-commission_en.pdf . 
126 See, for example, Fitch ratings. ‘EU Recovery Fund Is a Step Towards a More Resilient Eurozone’, 5 August 
July 
https://www.fitchratings.com/research/sovereigns/correct-fitch-ratings-eu-recovery-fund-is-step-
towards-more-resilient-eurozone-05-08-2020  and  S&P  Global  ratings.  ‘What  The  EU  Recovery  Fund 
Breakthrough  Could  Mean  For  Eurozone  Sovereign  Ratings’.  https://www.spglobal.com/ratings/en/research/ 
articles/200722-what-the-eu-recovery-fund-breakthrough-could-mean-for-eurozone-sovereign-ratings-11584176 

the  next  European  Commission  2019-2020. 

2020. 

for 

43 

 
 
                                                 
 
 
sever  the  direct  nexus  between  banks  and  sovereigns.127  Furthermore,  common  issuance  is 
likely to strengthen liquidity conditions on sometimes strained repo markets and improve the 
uniform  transmission  of  monetary  policy  through  the  provision  of  high-quality  liquid 
collateral.128 Lastly, the EU issuance can lend further support to the development of a single 
securities market in the EU, thereby contributing to enhanced private sector risk-sharing via 
the capital markets.  

Next  Generation  EU  can  increase  the  international  standing  of  the  euro  through  an 
enhanced supply of euro-denominated safe assets. The envisaged issuance of up to EUR 
850  billion  compares  to  around  EUR  2.2  trillion  outstanding  euro-denominated  debt 
securities  with  an  AAA  rating  at  the  beginning  of  2020  thus  representing  a  significant 
increase in high-rated euro-denominated debt (Graph 34). Common issuance of the intended 
size  will  add  depth  and  liquidity  to  the  market  for  high-quality,  euro-denominated  debt 
securities, making the euro more attractive as a reserve currency. It could likewise support a 
larger total international investor exposure to the EU by providing the low-risk component of 
balanced portfolios. The long foreseen time period over which funds raised under NGEU are 
to  be  repaid  –  i.e.  not  before  2028  and  not  after  2058  –  should  ensure  a  sizeable  market 
presence of the EU for a significant period of time. Furthermore, given the proposed coverage 
of  debt  repayments  through  the  EU  budget,  the  high  rating  for  common  EU  issuance  is 
expected to be preserved. The quick development of sustainable finance, and in particular of 
green bonds around the world, can favour the euro and increase the attractiveness of the euro 
area.  Indeed,  today,  green  bonds  are  in  majority  euro-denominated,  and  the  sustainable 
investment targets of EU’s recovery plan, and the development of an EU green bond standard 
can lead to an even more developed sector. 

Technological developments and the rise of digital currencies open new possibilities and 
challenges for the euro. The COVID-19 crisis has accelerated the digital transformation (see 
section  1)  and  the  use  of  digital  and  cashless  payment  methods.  Going  forward,  any 
innovation  related  to  the  digitalisation  of  money  and  payment  systems  might  also  have 
implications for the international  role of  the euro. To this  end, the Commission  adopted its 
Digital  Finance129  and  Retail  Payment  Strategies130,  containing  elements  supporting  the 
international  role of the  euro and the EU’s economic and financial autonomy. The possible 
future issuance of central bank digital currencies (CBDC) including by the ECB can help to 
increase  further  the  efficiency  of  payment  infrastructure  but  needs  to  be  further  assessed 
against its implications for monetary policy, financial stability and competition.131 

127  28%  of  outstanding  EU  benchmark  issuances  are  currently  held  by  banks.  See  European  Commission 
investor  presentation  of  28  September,  https://ec.europa.eu/info/sites/info/files/economy-finance/eu_  investor_ 
presentation_en.pdf.  
128 See, for instance, ECB (2020). “Financial Integration and Structure in the Euro Area”, March 2020. 
129 See COM(2020) 591 final, “Communication on a Digital Finance Strategy for the EU”, 24 September 2020. 
https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52020DC0591&from=EN.  
130 See COM(2020) 592 final, “Communication on a Retail Payment Strategy for the EU”, 24 September 2020. 
https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52020DC0592&from=EN. 
131 See ECB, “Report on a digital euro”, October 2020. https://www.ecb.europa.eu/pub/pdf/other/Report_on_a_ 
digital_euro~4d7268b458.en.pdf.  

44 

 
 
                                                 
5.2. Remaining missing elements of the EMU architecture 

Important  gaps  remain  in  the  architecture  of  the  Economic  and  Monetary  Union 
(EMU). While the Global Financial Crisis gave a strong momentum to reform, the political 
will to push towards completing the EMU has slowed somewhat in the second half of the last 
decade, against the backdrop of a more favourable economic context. Important elements are 
still missing, such as complete Banking Union and Capital Markets Union.  

Completing  the  Capital  Markets  Union  is  a  key  priority  of  the  Commission.  The  final 
Report of the High Level Forum on the Capital Markets Union has underlined that a complete 
CMU  is  key  to  rebuild  the  EU’s  economy  following  the  pandemic,  to  mobilise  long-term 
investments  in  new  technologies  and  infrastructure,  to  tackle  climate  change  and  to  deliver 
Europe’s New Green Deal and Digital Agenda. A complete CMU is also a precondition for a 
stronger international role of the euro.132 The Commission adopted a Capital Markets Union 
action  plan  in  September  2020  which  aims  at  integrating  national  capital  markets  into  a 
genuine EU-wide single market for capital. This is coupled with objectives of supporting the 
green,  digital,  and  resilient  economic  recovery  by  making  financing  more  accessible  to 
European  companies,  and  making  the  EU  a  safer  place  for  individuals  to  save  and  invest 
long-term.  

Despite  the  significant  progress  and  efforts  made,  the  Banking  Union  is  not  complete. 
Today,  the  EU  banking  sector  is  better  prepared  to  withstand  economic  shocks  than  it  was 
prior to the Global Financial Crisis. A significant amount of risk-reduction has taken place in 
the last decade, and overall, banks are better capitalised and less leveraged. However, there 
remains  scope  for  further  strengthening  it  in  a  number  of  areas.  A  stronger  Banking  Union 
would  bring  benefits  in  terms  of  ensuring  Europe’s  economic  and  financial  sovereignty, 
private  risk-sharing,  financial  integration,  financial  stability  and  economic  growth.  For 
example,  there  is  still  room  to  improve  the  integration  of  the  banking  sector  given  the  low 
levels  of  cross-border  consolidation  and  the  potential  to  strengthen  the  volume  of  cross-
border loans and deposits in the euro area. 

Discussions  are  also  ongoing  on  how  to  progress  on  several  elements  of  the  Banking 
Union.  In  December  2018,  the  Heads  of  State  or  Government  called  for  the  work  on  the 
Banking  Union  to  advance,  and  in  particular  to  define  a  roadmap  for  starting  political 
negotiations  on  the  European  Deposit  Insurance  Scheme  (EDIS).  In  addition,  the  Banking 
Union will not be complete until a fully robust system for dealing with ailing banks has been 
put  in  place.  In this  regard, Member States  have  already  agreed that the  European Stability 
Mechanism will provide a common backstop to the Single Resolution Fund in the form of a 
credit line.133 EU’s Heads of State or Government agreed to introduce the backstop by 2023 

132  See  “A  new  vision  for  Europe’s  capital  markets”,  Final  report  of  the  High  Level  Forum  on  the  Capital 
Markets  Union,  June  2020,    https://ec.europa.eu/info/sites/info/files  /business_economy_euro/  growth_  and_ 
investment/ documents/200610-cmu-high-level-forum-final-report_en.pdf. 
133 The Single Resolution Fund (SRF) may be used to ensure the efficient application of resolution tools and it is 
financed by the banking sector. A common backstop to the SRF is an essential element to ensure that the EU's 
single resolution mechanism is sufficiently robust and maintains real credibility. If the Single Resolution Fund 

45 

 
 
                                                 
 
at  the  latest,  while  an  early  introduction  is  currently  under  discussion.  As  a  last  resort,  the 
common  backstop  will  support  bank  crises  management  within  the  Single  Resolution 
Mechanism, and will be repaid via contributions from the European banking sector.  

The Commission’s Economic Governance Review is set to assess the effectiveness of the 
current framework of economic and fiscal surveillance. While the existing framework for 
economic  surveillance,  including  the  six-pack  and  two-pack  legislation,  has  helped  reduce 
public  deficits  and  debt  levels  and  address  macroeconomic  imbalances  in  the  past,  it  has 
grown increasingly complex over the years, also reflecting the fact that the economic context 
has  significantly  changed  since  the  rules  were  established.  At  the  same  time,  it  has  not 
prevented  overall  high  public  debt  levels  in  some  Member  States,  frequently  pro-cyclical 
fiscal  policies  and  a  less  growth-friendly  composition  of  public  finances.  Against  this 
background, in February 2020, the Commission launched a review of the effectiveness of the 
economic surveillance framework that aims to assess strengths and weaknesses of the current 
framework  with  regard  to  past  developments  and  consider  possible  changes  to  meet  future 
challenges. With the deep recession, activation of the general  escape clause of the Stability 
and  Growth  Pact,  and  new  policy  instruments  agreed  at  the  EU  level,  the  context  of  the 
debate has changed radically. The review has been put on hold in light of the pandemic, but 
the Commission will return to it once the immediate crisis is over and lessons can be drawn 
from the recent experience.  

The  establishment  of  the  European  Stability  Mechanism  (ESM)  during  the  sovereign 
debt crisis was a major milestone on the way towards a more stable EMU. In the context 
of  the  current  crisis,  the  ESM  established  a  further  preventive  backstop  via  its  Pandemic 
Crisis Support that is based on its Enhanced Conditions Credit Line (ECCL) available to all 
euro  area  countries.  However,  the  ESM  remains  an  intergovernmental  organisation.  In 
December 2017, the European Commission proposed for the ESM to be incorporated in the 
EU  legal  framework  establishing  the  European  Monetary  Fund  (EMF).131  The  Commission 
made  its  proposal  due  to  the  firm  belief  that  the  ESM  should  become  a  full  part  of  the 
European Union given its euro area wide goal. The integration would further strengthen the 
ESM’s institutional anchoring and improve its synergies within the EU legal  framework, in 
particular  to  articulate  its  role  with  the  competences  of  economic  policy  coordination 
conferred  on  the  Union,  in  terms  of  cooperation  with  the  Commission,  transparency  and 
efficiency  of  the  EU’s  financial  resources.  It  would  also  equip  the  ESM  with  a  dedicated 
political  accountability  mechanism  before  the  European  Parliament.  In  addition,  this  would 
also ensure that the ESM is subject to the same legal scrutiny that other institutions acting for 
the European public good face before the European Court of Justice. In contrast, the recent 
Next  Generation  EU  proposal  was  firmly  set  within  the  EU  legal  framework,  a  move  that 
clearly strengthens the EU and EMU institutional set-up. 

were  to lack the resources needed to deal with a bank crisis, a reserve of additional funds  would be available 
from which it can borrow as a last resort. 

46