COMMISSION STAFF WORKING DOCUMENT 2024 Report on the euro area Accompanying the document Recommendation for a COUNCIL RECOMMENDATION on the economic policy of the euro area
Date: 2023-11-21
Institutions: Directorate-General for Economic and Financial Affairs, European Commission
Subjects: economic growth, economic reform, energy crisis, euro area, fiscal policy, investment promotion, macroeconomics, stability pact, structural adjustment, sustainable development

EN 

  EN 

   EUROPEAN COMMISSION  Strasbourg, 21.11.2023  SWD(2023) 903 final  COMMISSION STAFF WORKING DOCUMENT 2024 Report on the euro area Accompanying the document Recommendation for a COUNCIL RECOMMENDATION on the economic policy of the euro area {COM(2023) 903 final}  
 
 
 
 
 
 
 
 
 
 
 
1. MACROECONOMIC OUTLOOK  

and  tighter  financial  conditions  are  set  to 
weigh  on  economic  activity.  Rising  nominal 
wages would only gradually lift real disposable 
incomes, in  turn  supporting  a  mild  rebound in 
consumer  spending.  Recent  survey  results  for 
the euro area point to weak economic activity, 
with  continued  weakness 
industry  and 
fading  momentum  in  services,  with,  however, 
certain  marginal  improvements  expected  in 
the  months  ahead (1).  With  exports  projected 
to  grow  at  a  moderate  pace  due  to  the  more 
challenging  global  environment,  the  growth  is 
set  to  be  driven  mostly  by  domestic  demand. 
Overall, the GDP for the euro area is expected 
to grow by 1.2% in 2024 and by 1.6% in 2025 
(Graph 1.1). 

in 

Energy  prices  have  gone  down,  while 
inflation  excluding  energy  and  food 
remains  high  though  falling  gradually. 
Euro  area  headline  inflation  fell  sharply  in 
October,  to  2.9%.  This  is  down  from  4.3%  in 
September, and as much as 7.7 pps from the 
peak  recorded  in  October  2022.  The  decline 
was  driven  primarily  by  falling  energy  prices, 
but also by a gradual broad-based moderation 
in  the  other  components.  Lower  energy  and 
commodity  prices, 
together  with  easing 
bottlenecks in the supply chains enabled non-
energy  prices  to  also  fall.  Yet,  food  inflation, 
although 
remains 
consistently  declining, 
elevated.  Services  inflation  also  decelerated, 
but  at  a  slower  pace  compared  to  other 
components  (to  4.6%  in  October,  after  an 
increase to 5.6% in July), against the backdrop 
of  wage  growth,  increasing  unit  profits  (see 
Box  3.1)  and  persistently  strong  demand  for 
contact-intensive  services  and  tourism.  The 
tightening monetary  policy  and  contractionary 
inflationary 
fiscal  policies  helped  ease 
pressures  (see  Section  2).  Overall,  headline 
inflation  is  projected  to  decline  in  the  euro 

(1)  European Commission, Business and consumer survey 

results, October 2023  

Macroeconomic developments 

led 

After  a  continued  rebound  in  2022,  the 
euro-area  economy  witnessed  a  strong 
deceleration this year.  In 2022, the growth 
boost  resulting  from  the  post-COVID  re-
opening  of  the  economy,  together  with  policy 
support, 
to  a  solid  3.4%  economic 
expansion.  Despite  the  rapid  rise  in  energy 
prices  in  the  winter  of  2022,  the  euro  area 
avoided a recession. The robust labour market 
has  been  and  remains  a  key  element  of 
macroeconomic  resilience  and  supportive  of 
aggregate demand. Still, high consumer prices 
tightening  financing  conditions  have 
and 
resulted  in  a  loss  of  growth  momentum  over 
the  course  of  2023.  For  2023,  GDP  for  the 
euro  area  is  expected  to  grow  by  0.6%,  with 
recording  negative 
some  Member  States 
growth for the year as a whole. 

Graph 1.1: Real GDP growth and contributions, 
euro area 

(1) data for EA20 if not indicated otherwise 
Source: European Commission 

A mild rebound in growth is expected due 
to easing of inflation and a strong labour 
market. Entering 2024, the still high inflation 

2 

-8-6-4-2024682016201720182019202020212022202320242025%ConsumptionInvestment (GFCF)Inventories investmentNet exportsReal GDP growthforecast 
 
   
 
area from 8.4% in 2022 to 5.6% in 2023, and 
then further down to 3.2% in 2024 and 2.2% 
in  2025.  Core  inflation (2)  is  expected  to  be 
slightly more persistent, however, increasing to 
5.1%  in  2023  from  4.0%  in  2022,  and  then 
subsequently  falling  to  3.2%  in  2024  and 
2.5% in 2025. (Graph 1.2) 

in  prices  over  the  previous  10  years  (Graph 
1.3).  In  a  number  of  countries,  including  the 
Baltics, Croatia and Slovakia, the shock is even 
stronger.  

Graph 1.3: Convergence of underlying inflation, 
euro area 

Graph 1.2: Inflation breakdown, euro area 

(1) HICP inflation excluding food and energy 
(2) 2019 - 2023 cumulated inflation compared to 2009 - 
2019 cumulated inflation 
Source: Eurostat, own calculations 

low 

labour  market 

levels,  standing  at  6.5% 

is  close  to  full 
The 
employment,  and  wage  growth 
is 
gradually  restoring  purchasing  power. 
Over  the  last  two  years,  unemployment  rates 
throughout  the  euro  area  have  stabilised  at 
record 
in 
September,  down  from  6.7%  in  the  same 
period  of  the  previous  year.  Meanwhile, 
employment continues to increase in almost of 
the  Member  States,  except 
Italy,  Latvia, 
Croatia and Estonia, recording from modest to 
moderate  contraction  of  their  employment 
rates  in  Q2  2023.  Employment  growth  is 
particularly  strong  in  low  energy-dependent 
sectors, notably some services (See Section 3). 
Despite  the  slowdown  in  activity  in  the  first 
part of 2023, the labour market remains very 
tight,  with  euro-area 
rate 
remaining at elevated levels (3% in Q2 2023). 
In  that  context,  wages  have  so  far  not  kept 
pace  with  inflation,  which  is  likely  due  to  a 
lagged  wage  bargaining.  In  2023,  there  are 
early  signs  of  wage  acceleration  (see  Section 
2),  although  real  wages  are  only  expected  to 
rebound  as  of  the  end  of  2023  and  recover 
moderately in the course of 2024. 

job  vacancy 

Source: European Commission 

  Energy  prices  are  expected 

The  decrease  in  energy  prices  over  2023 
has  partly  reduced  the  differences  in 
inflation  rates  between  the  euro-area 
countries. In 2022, the inflation dispersion in 
largely  driven  by 
the  euro  area  was 
differences 
reflecting 
inflation, 
in  energy 
difference  in  the  energy  mix  and  in  the 
sources of imported energy, as well as support 
measures implemented in the various Member 
States. 
to 
decrease  in  2023  for  most  Member  States, 
with  the  strongest  decrease  in  the  Member 
States  that  faced  the  sharpest  increases  in 
2022,  notably  the  Netherlands,  Estonia  and 
Belgium.  However,  the  correction  in  energy 
prices  remains  far  from  complete,  with  some 
countries  set  to  continue  recording  positive 
energy  inflation.  Moreover,  inflation  excluding 
food  and  energy  remained  high  in  most 
Member  States  in  2023,  due  in  particular  to 
the lagging effect of high energy prices. In the 
euro  area,  the  core  inflation  recorded  since 
2019 is comparable to the cumulated increase 

(2)  Core inflation is defined in this report as overall HICP 
inflation excluding energy, food, alcohol and tobacco. 

3 

BEHRDEEEIEELESFRITCYLVLTLUMTNLATPTSISKFIEA200%5%10%15%20%25%30%-5%0%5%10%15%20%25%Between 2019 and July 2023Over 2009-2019 
   
 
  
in  2023  denting 

The euro real effective exchange rate has 
appreciated 
cost 
competitiveness. 
In  2019  -  2022,  the 
depreciation in the value of euro compared to 
the  currencies  of  the  main  trading  partners 
supported the euro area cost-competitiveness. 
Since  then,  the  increase  in  inflation,  together 
with an appreciation in the euro against other 
currencies, has led to a deterioration in overall 
cost  competitiveness.  Within  the  euro  area, 
divergences  in  price  dynamics  have  led  to  a 
deterioration in the relative competitiveness of 
some  Member  States,  notably  the  Baltics  and 
some 
Slovakia 
rebalancing  could  also  be  observed 
(see 
Section 5). 

(Graph  1.4),  although 

differences between Member States. In several 
countries,  the  deterioration  in  the  energy 
balance  was  counterbalanced  by  a  solid 
performance  in  services,  particularly  travel 
(Spain  and  France).  This  helped 
services 
somewhat  reduce  current  account  imbalances 
across  the  euro  area.  The  euro-area  current 
account balance is expected to increase in the 
next years, although it is set  to remain below 
pre-pandemics  levels.  In  addition,  differences 
in  cost  competitiveness  between  Member 
States  may  be  a  cause  for  concern,  as  they 
may lead to emergence of new vulnerabilities 
(European Commission, 2023a). 

Graph 1.5: Current account composition, euro 
area 

Graph 1.4: Decomposition of the change in the 
real effective exchange rate (December 
2019-June 2023) 

(1) Four-quarter moving sum 
Source: European Commission 

The  economic  outlook  continues  to  be 
marked by major risks linked in particular 
to  geopolitical  tensions.  Measures 
to 
diversify  energy  sources  and  reduce  energy 
demand are supporting higher resilience of the 
euro  area.  Still,  geopolitical  tensions  will 
continue  to  keep  energy  prices  high  in  the 
medium  term.  Persistence  of  high  non-food 
and energy inflation is a key emerging risk. In 
particular,  the  euro  area  faces  uncertainty,  as 
to  whether  wages  can  be  adjusted  to  recoup 
losses in the purchasing power without driving 
up inflation. The risks of higher-than-expected 
inflation therefore remain strong. This, in turn, 
would  result  in  stronger  monetary  reaction 
that would adversely impact growth.  

In  the 
longer  term,  the  euro  area 
economy  faces  significant  structural 

Source: Eurostat, own calculations 

After  a  sharp  fall  in  2022,  current 
account balances have rebounded, easing 
concerns  about  short  term  risks.  The 
strong  deterioration  in  the  euro  area’s  energy 
balance  led  to  a  sizeable  negative  terms  of 
trade  shock,  which  resulted 
in  a  sharp 
reduction  in  the  euro  area’s  current  account 
surplus in 2022. In countries that had already 
recorded a deficit, the drop in current account 
balances  created  concerns  about  possible 
imbalances.  As  the  energy  shock  gradually 
dissipates,  the  euro-area  current  account 
bottomed  out  in  the  first  quarter  of  2023 
significant 
(Graph  1.5),  although  with 

4 

-20-15-10-50510152025EELTLVSLEUNLEADEHRMTATITSIPTCYBEFIIEFRELELLUChange in REER between 2019Q4 and 2023Q2HICP (REER-NEER)Change in NEERChange in REER (ULC)Change in REER (HICP)-6-4-202461617181920212223% of GDPSecondary incomePrimary incomeTravel servicesServices excl travelGoods excl energyEnergy goodsCurrent account 
     
     
This 

entails 

fragmentation  and  divergences 

challenges.  The  changing  global  geopolitical 
landscape entails long-term risks of persistent 
trade 
in 
economic  policies  of  global  actors  and  key 
trade partners of the euro area (see Box 5.1). 
In  addition,  the  demographic  outlook  for  the 
euro  area  is  that  of  a  shrinking  and  ageing 
population (3). 
long-term 
limitations in potential growth and risks for the 
sustainability  of  public  finances,  in  particular 
against  the  backdrop  of  persistently  slow 
productivity  growth  and  lack  of  innovation  in 
the  euro  area.  Moreover,  the  intensifying 
impact of climate change, as illustrated by the 
extreme 
and 
unprecedented  wildfires  and  floods  in  the 
summer,  is  set  to  weigh  on  economic  growth. 
It  also  calls  on  decisive  actions  to  accelerate 
the  green 
reach  climate 
objectives.    

transition  and 

conditions 

weather 

Policy implications  

“as 

Weaker  growth  in  2023  combined  with 
persistent 
pressures 
inflationary 
underscore  the  importance  of  continued 
consistency between monetary and fiscal 
policy.  To  bring  down  inflation,  the  European 
Central Bank (ECB) has decided on a series of 
hikes  bringing  policy  interest  rates  to  high 
levels. While the ECB has decided to pause the 
increase  in  policy  rates  in  October,  it  has 
repeatedly committed to setting them as high 
as  needed  for 
long  as  necessary”. 
Meanwhile,  fiscal  policy  coordination is  key  to 
helping monetary policy bring inflation back to 
its  medium-term  target  in  a  timely  manner. 
Member  States  should  adopt  coordinated  and 
prudent fiscal policies to keep debt at prudent 
levels  or  put  debt  ratios  on  a  plausibly 
downward path. While remaining agile in view 
of 
the  high  uncertainty,  achieving  a 
contractionary  fiscal  stance,  as  expected  in 
2023  and  2024,  will  contribute  to  restoring 
fiscal buffers over time and thus to improving 
the  sustainability  of  public  debt  in  some 
Member  States.  Besides the  need  to  maintain 

(3)  The euro area population is expected to decrease by 

4.5% between 2022 and 2100. 

5 

a  prudent  fiscal  strategy,  public  investment 
needs  to  be  maintained  and,  where  needed 
increased,  to  support  long-term  growth  and 
the green transition.   

The labour market has proven resilient so 
far  and  wages  have  reacted  moderately 
to the inflation surge but are expected to 
accelerate.  The  post-COVID  19  period  has 
been  marked  by  very  high  employment  and 
decreasing  unemployment.  The  strong  labour 
demand,  together  with  factors  limiting  labour 
supply,  have  resulted  into  labour  shortages 
that  are  widespread  across  occupations  and 
skill  levels.    Measures  to  increase  the  labour 
force, 
labour 
in  particular  through  active 
market  policies,  are  helpful  in  that  respect. 
Despite 
labour  market,  wages 
increased  less  than  inflation  in  2022  and 
2023, leading to an increase in unit profits and 
to decreasing purchasing power for workers. In 
countries  with 
in 
particular 
social 
consequences  on  low-paid  workers  have  been 
more  limited.  Going  forward,  real  wages  are 
expected  to  recover  part  of  the  past  losses 
and a fine balance needs to be struck between 
lost  purchasing  power  for 
regaining  the 
workers, 
limiting  second-round  effects  of 
wages  on  inflation,  and  avoiding  sustained 
competitiveness losses in some countries.  

for  minimum  wages, 

indexation  mechanisms, 

tight 

the 

the 

and 

rates 

The  tightening  of  monetary  policy  calls 
for  a  careful  monitoring  of  risks  in  the 
financial  sector.  The  rapid 
in 
increase 
accompanying 
interest 
tightening  of  financial  conditions  throughout 
the euro area have put a lid on credit growth. 
Slower  economic  growth  and  higher  interest 
rates  have  affected  the  housing  market, 
especially in countries where prices were over-
valued  and  where  household  debt  is  high 
(European  Commission,  2023a).  Several 
Member  States  recorded  a  fall  in  real  estate 
prices  in  2023,  with  impact  on  households’ 
wealth and commercial real estate companies. 
in 
Progress  made  by  euro-area  banks 
strengthening 
sheet  has 
increased 
resilience  and  generally 
equipped  them  well  to  respond  to  a  potential 
deterioration  in  asset  quality.  Meanwhile,  the 
regarding  non-bank 
risks  may  emerge 
insurers  and 
financial 

intermediaries  (e.g., 

their  balance 

their 

 
 
investment  funds),  which  are  less  regulated, 
and  on  which  less  information  is  available. 
Risk may also build up due to potential further 
asset price corrections, volatile markets, and a 
turning real estate cycle.  

High  energy costs  and  inflation,  together 
with geopolitical developments, underline 
the  need  to  support  the  euro  area’s 
competitiveness.  The  durably  higher  energy 
costs  in  the  euro  area  compared  to  global 
partners  together  with  the  increasing  labour 
costs  risks  leading  to  a  deterioration  in  the 
cost  competitiveness  of  euro-area  economies. 
These  shocks  have  already  undermined  the 
trade performance of energy-intensive sectors. 
Differences  in  price  levels  between  euro-area 
countries, 
including  for  non-energy  goods, 
have  so  far  not  been  alleviated  by  the 
decrease in energy prices. This is leading  to a 
deterioration  of  the  relative  competitiveness 
of  some  countries  vis-à-vis  euro  area  peers. 
Such an uneven impact across the euro area, if 
sustained,  may  also  feed  macroeconomic 
imbalances  (European  Commission  2023a).  In 
the long-term, the euro area’s competitiveness 
will  be  determined  by  its  ability  to  increase 
productivity,  in  particular  through  increasing 
skills  and  innovation.  Supporting  investment, 
both  public  and  private,  also  remains  a  policy 
priority. 
timely 
implementation of the investment and reforms 
set out in the national recovery and resilience 
plans  and  cohesion  policy  programmes  can 
spur  productivity  and  growth.  Improving  the 
business  environment  is  also  critical  to  boost 
investment and competitiveness in the private 
sector. Specifically, making further progress in 
the  Capital  Market  Union  would  help 
innovative  companies  access  to  the  different 
forms of finance for their investments.  

Accordingly, 

the 

6 

 
POLICY CHALLENGES RELATED TO HIGH 
INFLATION 

7 

 
 
 
 
  
 
 
2. FISCAL AND MONETARY POLICY MIX 

Persistently  high 
inflation  dynamics 
continue  to  require  fiscal  and  monetary 
policy  to  work  in  tandem.  After  the  highly 
supportive 
fiscal  and  monetary  stances 
adopted during the COVID-19 crisis, the rise in 
inflation prompted a shift in policy. As the ECB 
embarks  on  the  fastest-ever  tightening  of  its 
monetary stance, fiscal policies have a role to 
play,  steering  away  from  an  expansionary 
stance  that  could  feed  inflation,  including  by 
rolling  back  energy  support  measures.  For 
some  Member  States,  the  need  for  a  tighter 
fiscal  stance  is  also  reinforced  by  the  high 
debt and deficit ratios. At the same time, there 
is  a  need  for  public  authorities  to  continue 
support  to  the  cost  of  living  for  the  most 
vulnerable part of the population.  

Monetary policy  

The  ECB  has  responded  to  the  high 
inflation  shock  with  the  fastest-ever 
increase in policy rates since the creation 
of  the  monetary  union.  In  2021,  inflation 
started  to  rise  from  a  very  low  level  on  the 
back of COVID-19-related demand and supply 
mismatches  and  accelerated  sharply  in  the 
wake  of  Russia’s  aggression  against  Ukraine. 
Starting  in  July  2022,  the  ECB  increased  its 
policy rates by a total of 450 basis points over 
15  months  (Graph  2.1).  Although  current 
rates  are  close  to  historical  highs,  the  hikes 
since  June  2022  have  been  larger  and  faster 
than  in  past  cycles.  The  ECB  also  brought  its 
net asset purchases to an end. In March 2022, 
the  ECB  discontinued  net  asset  purchases 
under  the  Pandemic  Emergency  Purchase 
Programme (PEPP), and those under the Asset 
Purchase Programme (APP)  were concluded in 
June  2022  (4).   As  inflationary  pressures,  as 

is  expected 

gauged by core inflation, remain high, the ECB 
remain 
monetary  policy 
restrictive  in  order  to  achieve  a  return  of 
inflation to the  2 %  target.  At  the  same time, 
the ECB has clarified that the future monetary 
policy path will be data-dependent. 

to 

Graph 2.1: Central banks' key policy rates in 
the euro area compared to the UK and the US 

Source: Bank of International Settlements 

financial 

conditions. 

for  non-financial 

The  increases  in  policy  rates  have  led  to 
The 
tightening 
Commission’s  composite  cost-of-borrowing 
indicators 
corporations 
(NFCs)  and  households,  which  combines 
interest rates on all loans to corporations and 
all loans to households, started  to increase in 
2022,  driven  by  significant 
in 
interest  rates  (Graph  2.2).  The  tightening  in 
financial  conditions  led  to  a  drop  in  lending 
activities  and,  in  particular,  in  housing  loans, 
slowing  down  economic  activity  by  affecting 
investments.  Given 
the 
transmission  of  monetary  policy,  it  is  still 
challenging  to  determine  the  full  impact. 
Model-driven  assessments  have  estimated 

increases 

lags 

the 

in 

(4)  The reinvesting of the proceedings of maturing 

securities purchased under the APP was also stopped 

one year later, while reinvestments under PEPP are set 
to continue until the end of 2024.   

8 

012345671999200020012002200320042005200620072008200920102011201220132014201520162017201820192020202120222023%EA20UKUS 
 
 
 
   
 
that  the  euro  area's  real  GDP  growth  could 
face  a  noticeable  reduction  due  to  monetary 
policy tightening, with an average decrease of 
about  2  ppt  annually  from  2022  to  2025 
(Darracq Pariès et al., 2023).  

Graph 2.2: Cost of borrowing indicators 

financed  net  primary  current 
Nationally 
expenditure has been reduced in 2023, largely 
due to the partial phase-out of energy-related 
measures,  introduced  in  2022,  when  they 
induced  a  sizable  expansion.  A  reduction  in 
government  subsidies  for  private  investment 
(other  capital  expenditure)  also  contributed to 
the  contraction 
in  2023.  Conversely,  the 
expenditure financed by RRF grants and other 
EU  funds  is  set  to  increase  further,  reducing 
the contractionary nature of the fiscal stance. 
This  has  supported  investment,  while  public 
investment  financed  by  national  budgets  has 
been preserved, making a neutral contribution. 
(Graph 2.3).  

Graph 2.3: Euro area fiscal stance in 2023 

Source: European Commission 

increase. 

Sovereign  spreads  in  the  euro  area  have 
remained stable so far. By the end of 2021, 
in  line  with  the  expectations  on  the  path  of 
policy  rates,  10-year  government  bond  yields 
started  to 
In  September  2023, 
government  yields  in  euro  area  countries 
ranged  between  2.5 %  and  4.2 %,  compared 
to  a  range  of  -0.4 %  and  1.3  %  in  December 
2021,  thus  implying  a  level  shift  of  about  3 
ppt.  Overall,  the  transmission  of  rate  hikes  to 
sovereign bond markets since the start of the 
hiking  cycle  has  not  translated 
into  an 
excessive  widening  of  sovereign  spreads.  On 
the  other  hand,  statistics  on  lending  activities 
show  some  heterogeneity  (see  Section  4), 
suggesting  that,  in  the  longer  term,  the  real 
impact  of  the  monetary  policy  will  differ 
across Member States. 

FISCAL POLICY STANCE 

The  aggregate  contractionary  stance  in 
2023 supported the reduction in inflation. 
The  euro  area  fiscal  stance 
is 
estimated to be contractionary, at ½% of GDP. 

in  2023 

9 

Source: European Commission 

In 2024, the fiscal stance is set to remain 
contractionary,  with  large  heterogeneity 
across  Member  States.  The  Commission 
2023 Autumn forecast indicates that the euro 
area fiscal stance would remain contractionary 
in  2024,  by  around  ½%  of  GDP.  There  is  a 
wide  range  across  Member  States,  from  a 
contractionary stance of more than 2% of GDP 
to  an  expansionary  stance  of  1.5%.  Overall, 
the 
to  be 
contractionary  or  broadly  neutral  in  most 
Member States (Graph 2.4), while it is set to 
be  expansionary  in  five  Member  States.  A 
contractionary  stance  is  projected  in  all  high-
debt Member States but Portugal. 

is  expected 

stance 

fiscal 

01234567200320042005200620072008201020112012201320142015201720182019202020212022%Non-financial corporatesHouseholds-6.5-5.5-4.5-3.5-2.5-1.5-0.50.51.52.5BEELESPTFRITSKLUCYHRLTEELVIEFISIMTDENLATEA% of GDPRRF grants and EU fundsOther capital expenditureNationally financed investmentNationally financed  primary current expenditureFiscal stanceContractionary/ ConsolidationExpansionary/Relaxation 
   
   
Graph 2.4: Euro area fiscal stance in 2024 

Source: European Commission 

Energy-crises  related  support  measures, 
which  remained  sizeable  in  2023  are 
expected to be almost completely phased 
out  in  2024.  Persistently  elevated  energy 
costs  in  2023  have  led  many  Member  States 
to  continue  extending  support  to  households 
and  businesses.  The  Commission  estimates 
that the total cost of such measures amounts 
to 1.0% of the euro area GDP in 2023, a slight 
decrease  from  1.3%  in  2022.  Most  of  the 
measures are expected to be phased out in the 
next year, with a remaining budgetary cost of 
0.2% of GDP in 2024 (Graph 2.5). 

Graph 2.5: Budgetary cost of fiscal measures 
to mitigate the impact of energy price 
increases in 2023 and 2024 

IMPACT OF INFLATION ON PUBLIC 
FINANCES 

The high inflation has an impact on public 
finances  through  both  revenues  and 
expenditures,  with  a  strong  impact  of 
energy  measures.  On  the  revenue  side,  the 
favourable  composition  of  economic  activity, 
notably an increased share of consumption of 
goods,  and  the  increase  in  prices  in  tax-
intensive  goods,  in  particular  energy,  resulted 
in sizeable windfall revenues last year. On the 
expenditure  side,  the  price  adjustment  of 
social  transfers,  public  wages  and  new  public 
procurement  will  push  nominal  expenditures 
up  over  time.  Meanwhile,  the  measures  taken 
by  Member  States  to  support  the  economy  in 
the face of high inflation had a strong impact 
on  public  finance  developments.  The  lowering 
of  VAT  rates  and  excise  duties  on  energy 
products  reduced  the  revenue-to-GDP,  and 
public  subsidies,  which  have  reached  record 
levels  during  the  COVID-19  crisis,  remained 
high.  

Going forward, the high inflation will lead 
to  durable  upward  pressure  on  public 
expenditure.  As  the  price  adjustment  of 
many  public  expenditure  components  occurs 
with  a  delay,  the  high  inflation  will  continue 
exerting pressure on public expenditures in the 
coming  years.  In  addition,  after  a  decade  of 
decreasing costs of debt financing, the interest 
expenditure-to-GDP  ratio  is  expected  to  rise 
again.  The  average  maturity  of  government 
debt  in  the  euro  area,  which  determines  the 
speed  of  the  transmission  of  higher  interest 
interest 
rates 
payments, is distributed around 8 years. In the 
medium-term,  interest  payments  are  thus  set 
to  weigh  on  public  finances  much  more  than 
what  they  did  in  the  past,  diverting  resources 
from other priorities.  

to  an  actual 

increase 

in 

Source: European Commission 

Public  investment  will  continue  growing, 
also supported by  the RRF.  In  2023, public 
investment in the euro area is expected to rise 
to  3.1%  of  GDP  compared  to  2.8%  in  2019 
and  to  further increase to  3.2% in  2024.  This 
is  consistent  with  the  need  to 
increase 
investment  to  support  the  green  and  digital 

10 

-2.0-1.5-1.0-0.50.00.51.01.52.02.53.0PTBEESFRELITHRLTLVFINLIECYLUATDEEESIMTSKEA% of GDPRRF grants and EU fundsOther capital expenditureNationally financed investmentNationally financed  primary current expenditureFiscal stanceContractionary/ ConsolidationExpansionary/Relaxation-0.70-0.300.100.500.901.301.702.102.50202320242023202420232024202320242023202420232024202320242023202420232024202320242023202420232024202320242023202420232024202320242023202420232024202320242023202420232024ITELMTPTESHRATLVLTDESIFRBEEECYNLLUIESKFIEA% of GDPUntargeted price measuresUntargeted income measuresTargeted price measuresTargeted income measures(Taxes on) windfall profitsTotal 
   
  
 
transition.  In  particular,  around  one-third  of 
the  projected  increase  between  2019  and 
2024  is  due  to  new  investments  financed  by 
RRF grants.  

In a context of reduced fiscal space, it is 
critical that investments represent value-
for-money.  Spending  reviews  can  be  useful 
tool  to  support  fiscal  policy  objectives.  By 
identifying  and  weighing  efficiency  gains  and 
saving options, spending reviews can help free 
up fiscal space and reorient spending towards 
policy  priorities (5).  Spending  reviews  can  also 
be  usefully  coupled 
to  green  budgeting 
practices  to  identify  fiscal  measures  that  are 
environmentally  harmful.  Cutting  back  on 
support  to  fossil  fuel  consumption  and  other 
environmentally harmful subsidies would yield 
significant budgetary gains and generate fiscal 
space.  Aligning  price  incentives  with  climate 
internalise 
neutrality,  rewarding  efforts  to 
environmental  externalities  and  implementing 
the  polluter  pays  principle  are  also  key  to 
create  a  level  playing  field  for  sustainable 
alternatives  and 
the  green 
transition. 

to  bolster 

DEBT DYNAMICS AND 
SUSTAINABILITY 

The euro area public debt-to-GDP ratio is 
declining in 2023 and  2024, though from 
a  high  level.  Over  2023  and  2024,  the  euro 
area  debt-to  GDP  ratio  is  expected  to  decline 
by  2.8  pps.,  reaching  89.7%  of  GDP  in  2024. 
Most  euro  area  countries  are  expected  to 
experience  declining  ratios,  reflecting  the 
effects  of  high  inflation  on  nominal  GDP  (a 
favourable  snowball  effect).  This  effect  is 
particularly  strong  in  Member  States  with  a 
high  debt.  Notably,  between  2022  and  2024, 
public debt is predicted to decrease by around 
21 pps. in Greece, by 14 pps. in Cyprus, and by 
12 pps. in Portugal. Still, in 2024, six countries 

(5)  Spending reviews yielded results in social security 
savings for 2022, for example allowing Spain to 
identify relevant saving options and Slovakia to 
potentially save up to 0.3% of GDP. See for example SK 
and ES Stability Programme 2023-2026. 

will  continue  to  have  debt  ratios  surpassing 
100% of GDP, giving them limited fiscal space 
(Graph 2.6). 

Graph 2.6: Public Debt to GDP ratio, 2024 vs 
2022 

Source: European Commission 

by 

notably 

The  debt  projections  for  the  upcoming 
years  are  subject  to  high  uncertainty. 
Stochastic  simulations,  which  apply  a  large 
range  of  macroeconomic  shocks  around  the 
central  scenario,  suggest  that  euro  area  debt 
is likely to lie between 85% and 95% of GDP 
in 2024, and between 79% and 102% of GDP 
in  2028.    Several  factors  weigh  on  fiscal 
sustainability. In particular, the less favourable 
macro-financial  environment  is  expected  to 
negatively  affect  public  debt  dynamics  over 
the  coming  years.  The  increase  in  interest 
rates, 
heighted 
prompted 
inflationary pressures, is progressively feeding 
into interest payments and the debt dynamics. 
Moreover, population ageing acts as a drag on 
potential  growth,  while 
increasing  public 
spending. Against the background of uncertain 
growth  prospects,  also 
the 
geopolitical  environment,  these  risks  point  to 
the  importance  of  implementing  reforms  and 
investment  to  relaunch  growth  potential  and 
pursuing  responsible  fiscal  policies.  At  the 
same  time,  other  factors  may  mitigate  fiscal 
sustainability  risks.  These  factors  include  the 
lengthening  of  government  debt  maturities  in 
recent  years,  stable  financing  sources  and  EU 
initiatives such as the Next Generation EU and 
the Recovery and Resilience Facility (RRF). 

linked 

to 

Fiscal  sustainability, 
inclusive  growth, 
and  support  to  investment  and  reforms 

11 

020406080100120140160180ELITFRESBEPTFIATCYSIDESKHRMTNLLVIELTLUEEEA% of GDP20242022 
 
     
are  the  main  objectives  in  the  ongoing 
reform of the Economic Governance. With 
debt above the already elevated pre-pandemic 
levels  and  sustainability  challenges  remaining 
elevated  and  widespread  across  countries,  a 
renewed  emphasis  on  debt  sustainability  and 
economic growth is key. Given the challenging 
macroeconomic  environment,  Member  States 
should  adopt  stable  and  credible  debt 
reduction  paths.  The  Commission’s  proposals 
for  a  reform  of  the  Economic  Governance 
Framework  aim  at  promoting 
realistic, 
sustained  and  gradual  fiscal  adjustments 
guided  by 
country-specific  medium-term 
plans,  while  at  the  same  time  enhancing 
sustainable  growth  by  incentivising  reforms 
and investments.  

12 

 
 
3. WAGE DEVELOPMENTS AND DISTRIBUTIONAL 
IMPACT OF INFLATION 

consistent with its long-run downward trend. A 
number of explanations are thought to explain 
this  longer-term  downward  trend  in  average 
hours  worked,  including  the  rising  importance 
of services characterised by a lower number of 
hours  worked  per  worker.  Additional  factors 
keeping  average  hours  below  pre-2019  levels 
may  include  increased  sick  leave  and  labour 
hoarding  by  firms  facing  temporarily  lower 
demand (Arce et al., 2023). 

in 

Recent  developments  are  helping  to 
labour  market 
bridge  differences 
performance  across 
the  euro  area.  
Compared  to  the  pre-pandemic  average,  the 
drop  in  unemployment  since  2022  has  been 
greater  in  high-unemployment  countries.    The 
observed  levelling  up  of  unemployment  rates 
across  the  euro  area  continues  a  trend 
observed  before  2019,  but  may  also  have 
been reinforced  by sectoral  dynamics and the 
impact  of  the  energy  shock.  More  energy-
intensive  industries  (e.g.,  manufacturing  and 
transport),  which  performed  well  in  the  pre-
crisis  period  recorded  lower  job  creation (6) 
while  low  energy  consumption  sectors,  and  in 
particular  services,  performed  better  (Graph 
3.2).  The  energy  price  shock  dampened 
employment  growth  primarily  in  high  energy-
intensive sectors.  

Labour and skill shortages are signs of a 
very tight labour market. In 2022 and early 
2023  the  euro  area  vacancy  rate,  i.e.  the 
proportion of total jobs that are unoccupied or 
about to become vacant, hovered around 3% - 
the  highest  level  since  2008.  In  July  2023, 
around  24.5%  of  firms  reported  labour  as  a 
factor limiting production (7) and 74% of SMEs 

(6)  For a more in-depth assessment of the impact of the 
energy price shock on employment see European 
Commission, 2023g.  

(7)  Compared to about 17% before the pandemic. Source: 
European Commission Business and Consumer Survey. 

Labour markets developments 

Labour  markets  in  the  euro  area  are 
performing  well  despite  the  slowdown  in 
economic  activity.  Close  to  170  million 
people  were  employed  in the euro  area  in  Q2 
2023,  the  highest  number  ever  (Graph  3.1). 
Strong  employment  growth  is  supported  by 
increasing  labour  supply.  Despite  an  ageing 
population,  the  activity  rate  in  the  euro  area 
returned  to  its  long-term  upward  trend,  after 
the 
the 
pandemic.  The  unemployment  rate  stood  at 
about  6.7%  in  2022  and  6.5%  in  2023  (until 
September)  –  the  lowest  rate  recorded  since 
the creation of the monetary union.  

contraction 

temporary 

during 

Graph 3.1: Employment and hours worked in 
the euro area 

Source: Eurostat. 

to  pre-COVID 

Average  working  hours  have  not  fully 
recovered 
levels,  but 
resumed the steady  downward trend.  The 
number  of  working  hours  per  person,  which 
plummeted 
in  2020  due  to  confinement 
policies, recovered to a great extent to a level 

13 

320330340350360370380390400410420120000130000140000150000160000170000180000200020012002200320042005200620072008200920102011201220132014201520162017201820192020202120222023Hours per person employedNumber of peopleEmployment (lhs)Hours per person employed (rhs) 
 
   
 
that 

they 

face 

skills 
reported 
shortages (Eurostat,  2023).  Shortages  are 
particularly  strong 
in  the  services  sector. 
Meanwhile, skill shortages have become major 
bottlenecks  for  some  occupations,  including 
ICT, 
and 
healthcare. Reducing  skills  shortages  and 
mismatches, in particular by up- and re-skilling 
is 
workers,  can  boost  productivity  and 
essential  to  support  the  green  and  digital 
transition.  

construction, 

engineering 

Graph 3.2: Employment by industry according 
to the energy intensity of each industry 
(2019Q4=100) 

(1) Energy intensity is measured as Tera Joules per unit 
of value added. The different groups are defined 
classifying 55 sectors of the economy on the basis of the 
quartile of the sectorial distribution of energy intensity.  
Source: Eurostat.  

a 

long-term 

decreasing  working 

With 
age 
population, maintaining labour supply will 
policy 
remain  a  major 
challenge.  The  working  age  population  (20-
64-year-olds) reached a peak of 272 million in 
2009  (Graph  3.3).  It  declined  to  265  million 
in 2022 and is projected to continue falling to 
258 million by 2030 (8). Population decline and 
ageing  will  cause  GDP  to  decline  in  Member 
States 
varying  degrees.  By  2030, 
demographic trends are expected to negatively 
affect  the  level  of  GDP  in  most  euro  area 
the 
members, 

from  0.2% 

ranging 

to 

in 

(8)  Eurostat’s 2023 population projection. 

14 

Netherlands 
Commission, 2023b).  

to  7.6% 

in 

Italy 

(European 

Graph 3.3: Working age population and activity 
in the coming decades 

Source: EU Commission services based on Eurostat and 
OECD data and EUROPOP2023 population projections. 

the 

labour 

inactivity 

labour  and 

Policies to support labour supply can help 
address labour and skill  shortages.  Active 
labour  market  policies  play  a  key  role  in 
force 
boosting  employment  and 
participation  especially  in groups  with  relative 
high 
(e.g.,  women  and  youth, 
particularly  with  migrant  background)  and 
transition  of  workers  and 
easing 
jobseekers  in  the  labour  market.  Managed 
legal  migration  in  shortage  occupations  could 
also  help  addressing 
skill 
shortages,  especially  by  targeting  bottleneck 
occupations. Activating people of working age, 
in  particular  women,  young  and  older  people 
background; 
and 
improving  access  to  childcare  and  long-term 
care;  reducing  skills  shortages: 
improving 
working  conditions  in  certain  sectors;  and 
intra-EU mobility are vital for mitigating labour 
shortages  in  the  euro  area,  but  it  will  not 
in  all  shortage 
to  meet  needs 
suffice 
occupations 
Commission, 
(European 
2023c).  In complement to policies harnessing 
talents within the EU, including non-EU citizens 
already 
legal 
migration  from  non-EU  countries  can  help 
employers  fill  vacancies  at  all  skills  levels, 
including for occupations with a critical role for 
the  EU  economy  and  its  green  and  digital 

people  with  migrant 

legally  residing 

in  the  EU, 

90929496981001021041061081102019Q42020Q12020Q22020Q32020Q42021Q12021Q22021Q32021Q42022Q12022Q22022Q32022Q42023Q12019Q4 = 100High (12.5%)Mid-high (21.2%)Mid-low (21.6%)Low (23%)15017019021023025027029020022004200620082010201220142016201820202022202520352045million Active PopulationWorking age 
     
 
   
Graph 3.5: Nominal and real compensation for 
employee (y-o-y changes) 

transition  in  the  context  of  the  Green  Deal 
Industrial  Plan.  Given  the  size  of  its  labour 
market,  labour  migration  to  the  euro  area 
remains 
international  comparison 
in 
(European Commission, 2023d).    

low 

Wage developments  

to 

gradually 

  However, 

Increase  in  nominal  wages  are  helping 
recover 
households 
purchasing power. In the euro area, nominal 
compensation  per  employee 
increased  by 
4.3% in 2022 (Graph 3.4) and by 5.4% in Q1 
2023  (y-o-y),  a  record  high  for  most  Member 
States. 
in  real  terms,  wages 
decreased by 3.5% in 2022 (Graph 3.5), amid 
growing  concerns  for  the  adverse  social 
consequences  of  purchasing  power  losses, 
especially  for 
low-wage  earners.  Looking 
ahead, while nominal wage growth is likely to 
further  increase  over  the  next  quarters,  real 
wages are set to only increase from Q3 2023 
onwards (European Commission, 2023e). 

Graph 3.4: Nominal compensation per 
employee (2022-24) 

Source: AMECO and Autumn 2023 Forecast. 

Source: Real wages are computed using the HICP index 
as deflator. 

Increases  in  statutory  minimum  wages 
have  partly  mitigated the  impact  of  high 
inflation  on  low-wage  earners.    Statutory 
minimum  wages  rose  by  more  than  5%  in 
nominal  terms  in  all  Member  States  in  2022 
where  such  wages  are  in  place,  and  even  by 
more  than  10%  in  around  half  of  these 
countries  (Graph  3.6).  Such  increases  in 
statutory  minimum  wages  were  the  result  of 
substantial  increases  throughout  2022,  the 
January 2023 updates (9) and some updates in 
a  few  Member  States  after  January  2023. 
They have largely compensated the impact of 
high  inflation  on  the  purchasing  power  of 
minimum  wage  earners  in  half  of  Member 
States  with  statutory  minimum  wages.  The 
reflected  automatic 
increases 
in  2022 
indexation  adjustments  where 
such  a 
mechanism is in place (e.g., Belgium, France or 
Luxembourg), as well as discretionary updates 
the 
(e.g., 
Netherlands) (Eurofound,  2023).  Given 
the 
tight labour market, these increases have had 
no  impact  on  minimum  wage  employment. 
However, they have resulted in a compression 

Germany, 

Greece 

and 

(9)  Minimum wages are often updated annually, at the 
beginning of the year. In January 2023, the largest 
increases were registered in Latvia, with an increase of 
24%, and in Romania, Hungary, Poland, Lithuania, 
Croatia, Slovenia, Estonia, and the Netherlands, with 
increases between 10% and 20%. 

15 

02468101214LTLVEESKSIHRATBEPTNLLUEUDEEAFRFICYIEELESMTIT%202220232024-6-4-20246810200620072008200920102011201220132014201520162017201820192020202120222023%Real wage growth (HICP)Nominal wage growthNegotiated wages 
      
 
 
   
 
of the wage scale which may put pressure on 
collective bargaining going forward. 

Graph 3.6: Minimum wage in Member States 
with statutory minimum wages 

(1) CY excluded as the statutory minimum wage was 
introduced in 2022. Real wages are computed using the 
HICP index as deflator. 
Source: Eurofound. 

staggered, 

Real  wages  are  expected  to  recover 
gradually.  Collective  wage  contracts  are 
implying  an 
multi-year  and 
expectation for the ongoing wage acceleration 
to  persist.  This  may  in  turn  underpin  the 
dynamics  of 
In 
addition,  since  end-2022,  core  goods  and 
services 
and 
replaced 
unprocessed  food  as  the  primary  driver  of 
headline  inflation  in  the  euro  area  (ECB, 
2023a).  

inflation  for  some  time. 

energy 

have 

The  increase  in  corporate  profit  leaves 
scope for adjustment in real wages in the 
concerned  sectors  with  limited  second-
round  effects  on  inflation.  A  fine  balance 
needs to be struck between regaining the lost 
purchasing power for workers, especially those 
with 
limiting  second-round 
effects  of  wages  on  inflation,  and  avoiding 
competitiveness losses. As real wages recover, 
wage  dynamics  will  increasingly  contribute  to 
domestic  inflation.  In  particular,  the  dynamics 
of  inflation  will  crucially  depend  on  the  way 
unit labour costs and unit profits interact (Box 

incomes, 

low 

3.1)  (10).  After  their  strong  increase  in  recent 
years,  unit  profits  are  expected  to  decline  in 
the  course  of  2023  and  beyond  providing  a 
buffer  for  the  increase  in nominal  wages  and 
mitigating  pressures  on  consumer  prices.  To 
the  extent  that  wage  setting  across  the  euro 
area  and  the  EU, 
in  particular  for  new 
contracts,  reflect  an  expectation  that inflation 
will normalise over the medium-term, having a 
moderate impact on wage growth (11).   

Social implications  

income.  Household 

The strong labour market and supporting 
policy  measures  have  mitigated  the 
impact  of  inflation  on  households’  real 
disposable 
income 
declined  by  about  0.7%  in  the  year  ending  in 
Q4  2022  (Graph  3.7).  Rising  inflation  which 
led  to  falls  in  the  real  compensation  of 
employees  and  of  the  self-employed,  and  to 
falls in (net) social benefits. Policy measures –
income  measures  or  price  measures  -- 
mitigated  the  impact  of  high  inflation  and 
cushioned the drop in real disposable incomes. 
In  Q1  2023,  household 
incomes  have 
rebounded  in  real  terms  (+0.5  %)  as  the 
decline  in  real  wages  was  balanced  by  lower 
taxes,  higher  benefits  and  other  transfers 
(European Commission, 2023e).   A number of 
social  indicators,  including  the  number  of 
people  at  risk  of  poverty  or  social  exclusion, 
in  2022,  reflecting  the 
remained  stable 
resilience  of  the 
labour  market  and  the 
support mechanisms.  

living  had 
in  the  cost  of 
The  rise 
particularly  strong  impact  on  vulnerable 
groups.  As  low-income  households  spend  a 
higher  share  of  their  income  on  food  and 

(10)  In absence of a decline in the profit share, any wage 

increases beyond productivity gains will lead to higher 
inflation, increasing the risk of loosening inflation 
expectations and ultimately forcing the central banks to 
tighten monetary policy more than otherwise would be 
the case. See also Arce et al. (2023). 

(11)  Ex-post inflation indexation plays a relevant role only in 
a handful of countries (Belgium, Cyprus, Luxembourg, 
Malta). 

16 

-15-10-5051015202530DEBEELLUNLLVESFRIELTPTSKMTSIEE%Nominal growth (Jan 2022 to Jul 2023)Real growth (Jan 2022 to Jul 2023)Real growth (Jan 2022 to Jan 2023) 
   
 
energy, people  at  the  bottom  of  the  income 
distribution have experienced a higher increase 
in the cost of living than those at the top (1.7 
pps  higher  on  average).  The  gap  varies 
considerably across countries – the widest gap 
is  recorded 
low-income 
in  Latvia,  where 
households face an inflation rate almost 4pps 
higher than medium income ones (Caisl et al., 
Inflationary  pressures  were  also 
2023).   
stronger  for  older  people  and  those  living  in 
rural areas due to their lower ability to adjust 
consumption.  Because  of  the  unequal  impact 
on  population  groups,  the  financial  distress 
among  households 
income 
quartile  at  EU  level  rose  from  22.0%  in  July 
2021  to  29.1%  in  September  2023,  with  the 
largest  increases  observed  in  Estonia  (from 
1% to 30%). 

in  the 

lowest 

Graph 3.7: Real gross disposable household 
income growth and its main components 

(1) GDHI, gross disposable household income in the 
EA20. The nominal GDHI is converted into real GDHI by 
deflating values using the deflator (price index) of 
household final consumption expenditure. Net transfers 
notably include net social benefits and taxes on income 
and wealth (negative contributions). 
Source: Commission calculations based on Eurostat, 
National Accounts. 

Although  generally  poorly 
targeted, 
energy  measures  effectively  supported 
households.  More  than  half  of  the  energy 
support  measures  implemented  by  Member 
States consisted in price measures, which aim 
at reducing energy prices. Such measure were 
vulnerable 
poorly 
households. While they do contribute to reduce 
inequality  in  real  wages  and  in  welfare,  they 

targeted 

towards 

do it at a much higher cost than more targeted 
income  measures.  Altogether,  the  measures 
implemented  were  able  to  mitigate,  and  in 
several  Member  States  fully  offset, 
the 
negative impact of higher energy price on real 
wage  and  welfare  equality  across  income 
deciles (Amores et al., 2023).  

17 

-4-3-2-101234Sep-21Dec-21Mar-22Jun-22Sep-22Dec-22Mar-23percentage change in previuos year Compensation of employeeNet property incomeNet tranfersReal GDHI 
     
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
18 

Box 3.1: The increase in unit profits is a temporary phenomenon reflecting high inflationHigh inflation has put the distribution of value added between profit, compensation of employees and taxes under the spotlight. A number of empirical studies (1) have highlighted the increase in unit profits that has accompanied the increase in inflation in 2022. Based on a decomposition of the GDP deflator, unit profits appear to have increased steadily in 2022, growing at a record 9.3% (year-on-year) in Q1 2023 before decreasing slightly in Q2 (Graph 1a). (2) Unit profits have increased across all euro area countries and sectors, albeit with wide variations. In 2021, the increase in unit profit was led by industry, including manufacturing, energy and utilities, as well as mining, but other sectors, including services, caught up in 2022 (Graph 1b). The mirror image of the rise in profit has been a lower share of value added going to labour income. Accordingly, concerns that the rise in inflation may translate into extraordinary profits in some sectors, to the detriment of workers, led some European governments to take policy action. A number of Member States announced windfall taxes on sectors including banks (e.g. Spain and Italy) and food distributors (in Portugal).     A higher inflation does not point to weak competition, nor does a higher level of competition necessarily translate in lower inflation. In fact, in the short run, the relationship between competition and inflation depends on the nature of the shock. An increase in input costs will typically result in higher inflation in more competitive environments, as firms cannot absorb costs inflation through lower margin (OECD, 2022). Second, market power affects the absolute price level rather than the price changes. Still, in a high-cost inflation environment, consumers may have more understanding for a firm increasing its prices and are less likely to punish a firm by switching to a competitor if price increase. Altogether, this suggests that, while increasing competition may reduce prices in the long-term, competition policy cannot be a prominent short-term anti-inflation tool.     Empirical studies confirm that the increase in unit profits mainly reflects the rapid pass-through of higher input cost into selling prices and the comparatively slower adjustment in wages. When input prices rise, and assuming that the ratio between selling price and production costs – the mark-up - remains constant, the nominal profit per unit produced will also increase by the same proportion. Accordingly, the observed increase in unit profits does not necessarily entail higher profit margins. Recent evidence for Belgium and Italy indeed suggests that mark-ups played no role in the recent increase in profits (Colonna et al., 2023). Meanwhile, wages are generally set contractually or renegotiated at fixed intervals and hence adjust more slowly to shocks than prices. The rising contribution of ULC and other wage indicators from 2022 onwards points to a lagged reaction of labour compensation and suggest that the increase in unit profits may be temporary (Graph A). This is consistent with evidence from the US which suggests that higher unit profits could be a by-product of strong demand in markets where firms are price-takers and prices have risen to match demand to limited supply or margins could have increased temporarily in anticipation of future cost increases (Glover et al., 2023).    (1) See for example E. and E. Hahn (2023) and Hansen et al. (2023). (2) Unit labour costs are compensation of employees per unit of real GDP and unit profits are gross operating surplus over real GDP. -3-2-10123456720192020202120222023%Graph 1a: Decomposition of GDP deflatorUnit profitsUnit labour costsUnit taxesGDP deflatorSource: Eurostat and author's calculations.  -6-4-202468101220192020202120222023%Graph 1b: Decomposition of unit profts and sectoral contributionsServicesConstructionIndustry (excl construction)AgricultureUnit profitsNote: Analysis based on sectoral accounts. Unit profit growth is calculated based on sectoral value added (i.e. profits=value added minus compensation of employees). Source: Eurostat and author’s calculations.   
 
 
 
 
 
  
 
 
4. MACRO-FINANCIAL STABILITY 

a 

to 

resilient, 

turned,  both 

be 
financial 

The  euro  area  financial  system  has 
although 
proven 
tightening 
conditions  may 
increase  vulnerabilities.  With  the  increase 
in  interest  rates  and  tighter  credit  conditions, 
for 
the  credit  cycle  has 
households  and  corporates.  Asset  prices,  and 
in particular real estate prices, are also coming 
under pressure. Although such an environment 
represents 
financial 
challenge 
institutions, the euro area financial sector has 
proven  itself  resilient,  as  euro  area  banks 
liquidity 
benefit  from  strong  capital  and 
buffers,  as  well  as  improved  profitability.  At 
financial 
the  same 
be 
intermediation 
Further 
confronted  with 
progress  in  the  deepening  of  the  European 
Economic  and  Monetary  Union, 
including 
Banking  Union  and  Capital  Markets  Union, 
would make the euro area even more resilient.  

the  non-bank 

vulnerabilities. 

sector  may 

(NBFI) 

time, 

for 

Credit conditions and dynamics 

The  tightening  of  monetary  policy  and 
lending  standards  coupled  with  lower 
credit demand  led to a drop in new credit 
for  both  households  and  corporates.  The 
total  volume  of  new  household  loans  for 
house  purchase  fell  by  24%  in  the  second 
semester of 2022 and by a further 18% in the 
first  half  of  2023.  This  reverses  a  multi-year 
upward  trajectory  that  started  in  2015  and 
reflects  the  sharp  increase  in  borrowing  costs 
(Graph  4.1).  The  ECB’s  bank  lending  survey 
shows  that  the  drop  comes  from  falling 
demand  for  new  credit,  mainly  due  to  the 
interest rate level. A deteriorating outlook  for 
the  housing  market  and 
lower  consumer 
confidence  has  also  had a    significant impact 
credit. 
on 
Meanwhile, 
also 
decreased by 4% in the first half of 2023.  

for  household 
corporate 

the  demand 
new 

loans 

Graph 4.1: Cost of borrowing and volume of 
loans to households for house purchase 

Source: ECB 

Tightening  financial  conditions  weigh  on 
real estate prices. The euro area residential 
property  market  cycle  appears  to  be  at  a 
turning point, as higher interest rates weigh on 
housing  affordability.  Residential  real  estate  
prices  have  been  decreasing  considerably 
since  Q2-2022.  In  a  number  of  Member 
States, 
Austria, 
Luxembourg, 
including 
the  Netherlands  and  Portugal, 
Belgium, 
housing  prices  were  far  above  the  level 
suggested  by  fundamentals  in  2022  (12).   In 
the commercial real estate (CRE) sector, which 
is  more  sensitive  to  cyclical  developments, 
price  growth  dropped  sharply  into  negative 
territory  (Graph  4.2).  The  CRE  market  faces 
structural  changes  such  as  the  impact  of 
policies related to the green transition, a shift 
towards  e-commerce  and  higher  demand  for 
flexibility 
in  rentable  office  space  (ESRB, 
2023).   Some  of  these  changes  may  have 
been  accelerated  by  the  pandemic  crisis  and 
Russia’s invasion of Ukraine. While the ongoing 
is  putting  pressure  on 
price  correction 

(12)  For more detail see European Commission, 2023a. 

19 

11.522.533.544.530405060708090100110Jan-18May-18Sep-18Jan-19May-19Sep-19Jan-20May-20Sep-20Jan-21May-21Sep-21Jan-22May-22Sep-22Jan-23May-23Sep-23%billionVolume of loans for house purchase (lhs)Interest rate of loans for house purchase (rhs) 
 
   
 
investors, the speed and depth of the turn will 
determine  the  potential  for  stress  on  the 
financial  system  and  the  real  economy  (ECB, 
2023b) (13).    

Graph 4.2: Residential and commercial real 
estate prices in the euro area 

of  the  year,  the  ratio  decreased  slightly  for 
non-financial corporations (NFC) loans while it 
continued  to  increase  for  households.  Default 
rates  have  also  recently  shown  an  uptick  for 
both  corporate  and  retail  exposures.  The 
deterioration  of  economic  dynamics  and 
outlook in 2023 and higher interest rates may 
negatively impact asset quality. 

Financial sector developments 

(1) Year-over-year growth of nominal quarterly 
residential and commercial real estate prices  
(2) Q2-2023 already available and included for the 
commercial property price indicator 
Source: ECB 

Asset  quality  has  continued  to  improve 
but  there  are  risks  going  forward.  Banks’ 
non-performing loan (NPL) ratios continued to 
decline  –  to  historically  low  levels  –  although 
only marginally in the second half of 2022. At 
the  same  time,  according  to  the  ECB,  early 
warning  signs  of  asset  quality  deterioration 
became more pronounced, with some evidence 
of  an  increase  in  Stage  2  loan  ratios (14)  in 
2022.  They  remain  well  above  pre-pandemic 
levels  and  conceal  considerable  cross-country 
heterogeneity (ECB, 2023b). In the second half 

(13)  In 2023, the ESRB published a recommendation on 
vulnerabilities in the CRE sector in the EEA. Despite 
considering that there has been significant progress in 
closing CRE data gaps in recent years, such gaps persist 
in the CRE sector.  See ESRB, 2022a. 

(14)  Adopted in 2018, the International Financial Reporting 
Standard 9 (IFRS 9) aims to improve the recognition of 
banks’ credit losses, on the basis of a more 
forward-looking estimation and loan-staging approach. 
Stage 1 consists of performing loans, Stage 2 
underperforming loans that have seen a significant 
increase in credit risk, and Stage 3 credit-impaired 
loans. 

in 

interest 

increase 

The 
interest  rates  has 
supported  bank  profitability  but  entails 
other risks. Banks’ return on equity increased 
from an average of 1.9% at the end of 2020 
to  6.8%  at  the  end  of  2022  (Graph  4.3), 
supported  by  higher 
low 
loan-loss  provisions  and,  overall,  a  relatively 
slow adjustment of deposit rates. In 2023, the 
potential  deterioration  in  asset  quality  could 
increase 
(losses  and 
provisions).  In  addition,  rising  competition  and 
a reallocation of funds from overnight to term 
deposits and wholesale funding might lead to 
an 
costs,  eroding 
funding 
increase 
profitability.   

the  cost  of 

rates, 

risk 

in 

Capital  levels  and  asset  quality  remain 
robust  in  the  euro  area  banking  sector. 
The  Common  Equity  Tier  (CET1)  capital  ratios 
of  banks  declined  by  0.2  pps  in  2022,  to 
15.7%,  reflecting  stronger  lending  and  higher 
average  riskiness  of  total  assets.  However,  it 
stabilised  at  15.8%  in  Q1-2023.  In  addition, 
the  2023  European  Banking  Authority  (EBA) 
stress  tests (15) confirmed  the  resilience  of 
European  bank’s  capitalisation,  with  capital 
ratios  above  the  minimum  requirements  for 
almost all banks, even in an adverse scenario.  

The  banking  sector  holds  substantial 
liquidity  buffers  and  maintains  strong 
funding  ratios.  Liquidity  buffers  mainly  take 

(15)  The stress test involved 70 banks from 16 EU and EEA 
countries (of which 57 were euro area banks), covering 
75% of the EU banking sector assets. Compared to the 
previous test, it included 20 additional banks and a 
detailed analysis on banks’ sectoral exposures. See EBA, 
2023. 

20 

-14-10-6-226102001Q12002Q12003Q12004Q12005Q12006Q12007Q12008Q12009Q12010Q12011Q12012Q12013Q12014Q12015Q12016Q12017Q12018Q12019Q12020Q12021Q12022Q12023Q1%Residential real estateCommercial real estate 
  
 
 
the  form  of  central  bank  reserves  and 
government  bonds. 
In  addition,  the  high 
reliance  on  customer  deposits  and  market 
funding  via  bonds  (representing  respectively 
around  50%  and  15%  of  banks’  liabilities  in 
the  euro  area)  helped  increase  the  resilience 
of the euro area banks’ funding base. Overall, 
banks’ net stable funding ratios have declined 
only slightly since the end of 2021 and remain 
well  above 
requirements.  The 
gradual  repayment  of  the  ECB  targeted 
long-term  refinancing  operations  (TLTRO  III) 
has so far not put strain on the funding ratios 
of banks. 

regulatory 

Graph 4.3: Euro area bank stability indicators 

and  turning  real  estate  cycle.  The  growing 
interconnectedness  between  NBFI  and  the 
banking  sector  means  that  distress  in  one 
sector  may  affect  the  financial  system,  with 
unwarranted  effects  on  the  real  economy. 
Improving  data  quality  and  coverage  of  the 
NBFI  sector  to  enhance  its  monitoring  is 
therefore  key 
financial 
stability (ESRB, 2022b).  

for  safeguarding 

Graph 4.4: Euro area financial corporations 
(total asset share) 

Source: Eurostat 

(1) NPL ratio covers gross non-performing debt 
instruments as a percentage of total gross debt 
instruments 
Source: ECB 

Deepening of the Economic 
Monetary Union and policies to 
improve financial stability  

Meanwhile,  the  NBFI  sector  requires 
continued  monitoring.  The  NBFI  sector 
accounts  for  more  than  half  of  the  assets  of 
financial  corporations’ (including banks) in the 
euro  area  (Graph  4.4).  Assets  of  investment 
funds  and  other  financial 
intermediaries 
account  for  about  40%  of  European  financial 
sector  assets.  Non-bank  credit  granted  to  the 
NFCs  stood  at  around  20%  of  external  debt 
funding  at  the  end  of  2022,  and  more  than 
50% of newly-issued NFC debt was purchased 
by  NBFIs.  Credit  risk  in  the  aggregated  NBFI 
sector  declined  during  2022  (ECB,  2023b). In 
addition,  insurers’  profitability  and  solvency 
remain robust in the euro area. Still, the NBFI 
sector  remains  vulnerable  to  price  corrections 
due to macroeconomic uncertainty, a potential 
increase  in  the  cost  of  risk,  volatile  markets 

In 

financial 

stability. 

Macroprudential  policy  contributes  to 
safeguard 
a 
high-uncertainty  environment,  with  downside 
risks  to  economic  growth,  macroprudential 
policy can help strengthening resilience of the 
banking  and  financial  system.  In  that  respect, 
capital-based  and  borrower-based  measures 
are  complementary.  According  to  the  ESRB, 
macroprudential  policies  in  several  euro  area 
Member  States  tightened  between  April  2022 
and  March  2023,  including  as  regards  capital 
buffers (ESRB, 2022c).  

Progress in the Banking Union contributes 
to  the  resilience  of  the  euro  area’s 
financial system.  Ensuring financial  stability 

21 

024681012141618012345678201520162017201820192020202120222023%%Return on equity (annual data) (lhs)NPL gross ratio (lhs)CET 1 ratio (rhs)11%37%9%3%17%23%Central banksCommercial banksInsurance corporationsPension fundsInvestment fundsOther financial intermediaries 
  
   
the 

recalled 

challenges,  as  well  as 

is  crucial  at  a  time  of  high  inflation  and 
tightening  financial  conditions.  The  banking 
turmoil  caused  by  the  failure  of  several 
mid-sized banks in the US and the collapse of 
a  large  Swiss-based  bank  in  spring  this  year 
has 
importance  of  sound 
regulation and effective supervision, as well as 
of  a  predictable  crisis  management  and  and 
ensuring  better protection of all depositors. In 
particular,  the  Single  Supervisory  Mechanism 
(SSM)  plays  an  essential  role  in  ensuring  that 
banks  are  well  prepared  for  and  resilient  to 
adverse economic and financial developments. 
The  SSM  has  rapidly  adapted  to  emerging 
supervisory 
to 
unexpected  adverse  events,  such  as  the 
COVID-19 pandemic  and  the  Russian  invasion 
of  Ukraine  and  subsequent  economic  turmoil. 
As part of the work on the Banking Union, the 
Commission  proposed  a  reform  of  the  bank 
insurance 
crisis  management  and  deposit 
framework  in  April  2023.  It  aims  to  broaden 
the  applicability  of  resolution  powers  to 
mid-sized  and  smaller  banks,  while  improving 
resolution  funding  arrangements,  including  by 
facilitating  a  more  flexible  use  of  national 
deposit  guarantee  funds.  The  review  of  the 
insurance 
crisis  management  and  deposit 
should  pave  the  way  for  further  progress 
towards  the  completion  of  the  Banking  Union, 
including  a  European  Deposit 
Insurance 
Scheme and deeper market integration. 

in 

the 

digital 

payments 

automated 

inclusion.  Moreover, 

everywhere  in  the  euro  area.  The  digital  euro 
would  be  complementary  to  cash.  Benefits 
include  safeguarding  the  key  role  of  risk-free 
public  money  for  the  monetary  system  and 
it 
enhancing  financial 
could help support the digital transition, reduce 
fragmentation  and  promote  innovation  in  the 
European payment system. In that context, the 
digital  euro  could  support  FinTech  innovation 
by  providing  a  common  and  pan-euro  area 
standard  on  which  innovative  use  cases,  such 
as 
a 
machine-to-machine  environment,  can  be 
developed,  while 
euro’s 
interoperability  with  the  EU  Digital  Identity 
Wallet could provide for a seamless customer 
authentication  process  and  add  another  layer 
of  privacy  in  retail  payments.  A  digital  euro 
would  also  contribute  to  strengthening  the 
international  role  of  the  euro  and  Europe’s 
open  strategic  autonomy.  On  28  June  2023, 
the  Commission  has  adopted  a  legislative 
proposal  that  would  establish  the  digital  euro 
and 
its  essential  aspects.  The 
ultimate decision on its eventual issuance lies 
with  the  ECB,  who  could  start  issuing  the 
digital euro after completion of the legislative 
process. In parallel with the retail digital euro, 
the ECB is engaging in exploratory work on the 
potential  of  new  technologies  for  existing 
wholesale settlement systems. 

regulate 

Ratification  of  the  amended  European 
Stability  Mechanism  (ESM)  Treaty  would 
the  euro  area’s 
further  strengthen 
stability  architecture 
macro-financial 
(16).   The  ESM  reform  was  agreed  in  2020  by 
Eurogroup  members,  however  as  the  amended  ESM 
Treaty has  not yet been fully  ratified, the reform has 
not  been  finalised.  The  ratification  of  the  amended 
ESM  Treaty      would  operationalise  the  ESM’s 
financial backstop to the Single Resolution Fund 
(SRF),  make  crisis  management  arrangements 
more  credible  (see  Box  4.1).  By  providing  a 
common  backstop  for  the  funds  available  to 
manage  a  bank  crisis,  the  amended  ESM 

(16)  See the ratification details on the Agreement Amending 

the Treaty Establishing the ESM: 
https://www.consilium.europa.eu/en/documents-
publications/treaties-
agreements/agreement/?id=2019035&DocLanguage=e
n 

from 

NBFI  vulnerabilities  also  highlight  the 
need  to  strengthen  the  resilience  of  this 
macroprudential 
a 
sector 
perspective.  Structural  vulnerabilities  related 
to liquidity and leverage highlight the need to 
progress  on  policies  aimed  at  enhancing 
liquidity  preparedness  to  meet  large  margin 
and  collateral  calls  in  derivatives  and  repo 
markets, containing leverage-related risks, and 
tackling 
in  open-ended 
investment funds. 

liquidity  mismatch 

Introduction  of  a  digital  euro  could  spur 
efficiency and innovation in the European 
payments  markets,  unlock  benefits  for 
the  euro  area  economy,  and  foster  the 
international  role  of  the  euro.  The  digital 
euro  is  a  digital  form  of  central  bank  money, 
which  would  offer  consumers  and  businesses 
an  additional  choice  for  their  payments 

22 

 
 
Treaty  would  limit  divergence  in  financial 
conditions. 

the 

need 

emphasises 

Financial risks related to nature loss and 
climate  change  need  to  be  further 
assessed and monitored. As regards climate 
change,  the  ECB/ESRB  Project  Team  (ESRB, 
2022d) 
for  a 
macroprudential approach as regards systemic 
aspects  of  climate-related  risk.  In  2023,  the 
European Commission mandated the European 
Supervisory  Authorities  and  asked  the  ECB  to 
undertake  a  coordinated  one-off  assessment 
of  financial  stability  risks  in  line  with  the 
Fit-for-55  package.  The  outcome  of  that 
assessment,  expected  in  Q4-2024/Q1-2025, 
will inform the future work programme of the 
Union in that area. 

23 

Box 4.1: Financial architecture of the euro and role of the ESMThe European Stability Mechanism (ESM) reform, agreed in 2020 by Eurogroup members, entrusts, among other changes, the ESM to become the backstop to the Single Resolution Fund once the amended ESM Treaty is fully ratified. With its contribution to the funds available in case of a bank resolution, the common backstop would help ensuring that the ability to provide funding for resolving banks is delinked from the creditworthiness of the Member State where a bank is located, thus limiting divergence in financial conditions. The introduction of a common backstop to the Single Resolution Fund would thus strengthen and add credibility to the euro area’s crisis management toolkit. The proposed ESM reform aims to simplify and clarify the eligibility conditions to access ESM precautionary credit lines and it tasks the ESM with the monitoring of macro-financial risks in the euro area to prepare for potential adjustment programmes. However, as the amended ESM Treaty has not yet been fully ratified, the reform has not been finalised. In the meantime, following its accession to the euro area, Croatia joined the ESM in March 2023. The amendments to the ESM Treaty have not addressed the issue related to its institutional nature. The ESM remains a purely intergovernmental body operating under public international law. Recently, European Court of Auditors (ECA) published a special report on the EU’s financial architecture recommending that, once the ESM Reform is fully ratified, a broader reflection on a possible integration of the ESM in the EU legal framework takes place. (1) Before the ECA report, the case for an ESM integrated into the EU legal framework has been made on several occasions. For example, the “Five Presidents’ report on completing the Economic and Monetary Union”, issued in 2015, underlined that the ESM’s intergovernmental structure entailed a complex governance and lengthy decision-making processes, and advised to integrate the institution within the EU Treaties. Similar positions were adopted by the European Parliament (2) when reflecting on the future of the Economic and Monetary Union.   In 2017, the European Commission presented a proposal to integrate the ESM in the EU legal framework through its transformation into a union body, the “European Monetary Fund”. The Commission’s proposal aimed at strengthening the institutional anchoring of the ESM and aligning its governance with other EU bodies through the introduction of qualified majority voting and increased accountability towards the European Parliament. Overall, the integration of the ESM into the EU legal framework could simplify the ESM’s governance and make it more agile, allowing to respond to any unfolding crises more promptly and efficiently.  (1) The ECA recommends that by 2025, the European Commission engages with the Council and the parliament with a view to finalise the integration of the ESM into the EU legal framework. See ECA, 2023. (2) See European Parliament, 2013.  
 
 
   
 
 
ENHANCING EURO AREA 
COMPETITIVENESS 

24 

 
 
 
 
 
5. STATE OF PLAY ON COMPETITIVENESS 
DEVELOPMENTS 

The  fast  rise  in  both  energy  prices  and 
nominal  wages  since  2022  has  dented 
cost competitiveness in the euro area and 
heightened  divergences.  The  significant 
increase in energy prices since 2021 compared 
to trade partners puts euro area companies at 
a  disadvantage  on  export  markets.  The 
depreciation  of  the  euro  in  2021  and  part  of 
2022 compared to the rest of the world might 
have offset part of the deterioration. Still, the 
negative impact on exports has been visible in 
more  energy-intensive  countries  and  sectors, 
putting  the  strengthening  of  the  euro-area 
competitiveness 
fore. 
Differences  in  inflation  across  the  euro  area 
(see  Section  1),  raising 
remain  elevated 
concerns  about  reallocation  pressures  in  a 
context  of  global  fragmentation  and  the 
developments of internal imbalances.   

political 

the 

to 

to 

innovate. 

In  the  longer-term,  productivity  growth 
and  the  ability  of  the  euro  area  to 
innovate will drive competitiveness. Aside 
from  relative  production  costs,  multiple  non-
cost  factors  contribute  to  the  euro  area’s 
competitiveness,  including  in  particular  the 
ability 
makes 
competitiveness  a  multi-dimensional  concept 
that  reflects  the  ability  for  an  economy  to 
grow  within  an 
integrated  trade  system 
without  creating  imbalances.  In  that  respect, 
the  persistent  gap  in  productivity  growth 
compared  to  international  peers,  and  rising 
risks of geoeconomic fragmentation could put 
the  euro  area  at  a  disadvantage  (see  Box 
5.1).  

This 

Price and cost competitiveness     

High  energy prices in  the  euro area  have 
its  cost  competitiveness  with 
eroded 
international  partners.  The  global  increase 
in  energy  prices  has  affected  the  euro  area 

25 

more  than  several  of  its  trading  partners.  In 
particular, in 2022, electricity prices rose more 
steeply  than  in  the  US  and  other  trade 
partners  (Tertre  et  al.,  2023)  (Graph  5.1). 
Similarly, in  2022  wholesale  gas  prices in the 
euro  area  were  on  average  13  times  higher 
than  in  2020,  while  those  in  the  US  and  Asia 
were  3.5  and  9  times  higher  respectively 
(Emter  et  al.,  2023). The  share  of  firms 
reporting  an  increase  in  energy  costs  as  a 
barrier to investment rose to 87% in 2022, up 
from 69 % in 2021 (EIB, 2023a).  

Graph 5.1: Electricity prices in selected euro 
area countries and international peers 

(1) *NP stands for wholesale electricity prices of the Nord 
pool market (NO, DK, FI, SE, EE, LT, LV) 
(2) **EPB5 stands for European Power Benchmark. It 
represents the weighted average of wholesale electricity 
prices of main EU electricity markets (DE, ES, FR, NL) and 
Nord pool market (NO, DK, FI, SE, EE, LT, LV) 
(3) ***USA is the arithmetic average of the day ahead 
prices of the following most representative US power 
Hubs: PJM Western, NYISO Hudson Valley, MISO Indiana, 
ISONE Internal , ERCOT North , CAISO SP15. 
Source:: S&P Global Platts, Japan Electric Power 
Exchange (JEPX), Indian Energy Exchange Limited IEX 
India 

Despite  their  substantial  drop  since  the 
beginning  of  the  year,  energy  prices  in 
the euro area are likely to remain higher 

050100150200250300350ITFRNLDEUKEPB5**ESJapanNONP*AustraliaUSA***IndiaEUR/MWh2022Avg 2021-2017 
 
   
In  particular,  there 

is 
the  medium-term. 
potential  to  increase  resource  and  pollution 
taxes in line with the polluter pays principle, as 
these  taxes  only  make  up  a  small  share  of 
environmental  tax  revenues,  accounting  for 
3.5%  of  environmental 
in 
2021 (European 
2023f). 
Environmental  taxes  can  be  less  distortive 
than  other  more  commonly  used  types  of 
taxation,  e.g.,  labour  or  capital  taxation,  that 
were  designed  primarily  with  the  objective  to 
raise revenues. 

Commission, 

revenues 

tax 

the  euro’s 

Overall, 
real  effective 
exchange  rate  appreciated  compared  to 
world trading partners in 2023 and trade 
performance  in  energy-intensive  sectors 
suffered. The real effective exchange rate of 
the  euro  vis-à-vis  a  broad  range  of  trading 
partners  depreciated  in  2021  and  in  the  first 
part of 2022 but it appreciated more recently. 
As  of  Q2  2023,  the  euro’s  real  effective 
exchange  rate  (HICP  based)  appreciated  by 
about 2 pps since Q4 2019.  

Graph 5.3: Euro Real Effective Exchange Rate 

(1) REER refer to the real effective exchange rate of the 
euro against the currencies of 37 of the euro area’s most 
important trading partners. A positive (negative) change 
corresponds to an appreciation (depreciation) of the euro. 
Source: European Commission. 

area 

companies 

Euro 
competitiveness  at  an  all-time 
especially 

their 
low, 
energy-intensive 

high 

rate 

in 

than  before  the  crisis.    In  particular,  the 
substitution  of  Russian  gas  supplies  could 
imply  structurally  higher  costs  and  prices (17). 
The EU has stepped  up efforts to move away 
from  fossil  fuels  to  renewable  energy  but 
during  the  transition  its  competitiveness  will 
continue  to  be  affected  by  many  factors 
including the price of imported energy.  

Graph 5.2: Growth in unit labour costs 
(average annual growth nominal ULC) 
between 2016-19, 2020-22, Q1 and Q2 2023 
and 2024 forecast 

Source: Eurostat and EU Commission Economic Forecast 
Autumn 2023 

Unit  labour  costs  (ULC)  accelerated  in 
most  countries  in  2023.  ULC  increased 
markedly  in  the  year  ending  in  Q1  2023  in  a 
number  of  euro  area  countries  most  notably 
the  Baltic  countries  and  Slovakia  (rising  to 
significantly  higher  than  pre  pandemic  level) 
(Graph 5.2). This considerable rise in ULC was 
mainly  due  to  sharp  wage  increases,  while 
productivity  stagnated. 
In  2024,  ULC  are 
expected  to  slow  down  as  wage  growth 
moderates  and  productivity  is  expected  to 
Increased  use  of  environmental 
increase. 
taxation  could  help  reduce  the  burden  on 
labour,  further  reducing  unit  labour  costs  and 
improving  the  EU’s  cost  competitiveness  over 

(17) The replacement of Russian gas pipeline supply by a 
diversified supply of LNG via cargoes. LNG includes 
processes (liquefaction, transport by sea at very low 
temperatures, regasification) which result in higher 
costs as compared with gas delivered by pipeline.  

26 

-505101520EELVLTSILUHRBEATSKIENLPTDEFIFRESELITCYMT%2016-192020-22Q1 Q2 2023 average2024F92949698100102104106108110Mar-19Jun-19Sep-19Dec-19Mar-20Jun-20Sep-20Dec-20Mar-21Jun-21Sep-21Dec-21Mar-22Jun-22Sep-22Dec-22Mar-23Jun-23REER(ULC)REER(Deflator)NEER 
      
 
   
sectors  such  as  chemicals  (18).   Looking  at 
trade  developments,  euro  area  export  growth 
reflects 
over 
the  past  2  years  mainly 
depressed  global  demand  and 
supply 
bottlenecks, with energy costs having a limited 
impact  (19).   However,  exports 
in  energy-
intensive sectors have decreased strongly over 
the  past  year.  Exports  of  mineral  products, 
basic metals and chemicals were affected the 
most (Graph 5.4).  

Graph 5.4: Energy intensity and euro area 
export growth by sectors 

Source: Eurostat. 

the 

in  2022, 

than  10% 

High inflation has had a particular impact 
on  SMEs.  While  headline  inflation  reached 
more 
inflation 
experienced  by  businesses  in  certain  sectors 
was much higher, with rates of up to 28.5% in 
the  energy-intensive  industries  and  55%  in 
energy  renewables  in  the  third  quarter  of 
2022, followed by agri-food (over 15% in the 
first  half  of  2022)  (20).   This  inflation  had 
impacts on SMEs in a variety of ways: on late 
payments,  bankruptcies, 
the 
adoption  of  digital  and  green  technologies, 

investment, 

(18)  European Commission Business and Consumer Survey 

(BCS). 

(19)  ECB modelling shows that the recent energy supply 
shock has contributed to dampen export growth 
although its relative importance was lower than the 
deceleration in global demand conditions and the 
effects of supply bottlenecks. See Emter et al., 2023.  

(20)  European Commission, 2023g. 

participation  in  public  procurement,  access  to 
skilled  labour  and,  ultimately,  profitability. 
While  the  effect  of  each  impact  in  isolation 
may  appear  small,  the  total  effects  add  up 
significantly  from  the  perspective  of  a  single 
firm.  The  effect  is  particularly  pronounced  on 
those  firms  that  were  unable  to  pass  cost 
increases onto consumers – more often SMEs. 

Over  the 
last  2  years,  the  relative 
competitiveness  of  the  economies  of  the 
euro  area 
countries  has  diverged 
considerably.  Since  December  2019,  the 
currencies of the Baltic countries and Slovakia 
appreciated  significantly  in  terms  of  real 
effective  exchange  rate  (REER)  compared  to 
the  euro  and  the  currencies  of  other  trading 
partners.  Such 
in  price 
competitiveness,  if  sustained,  raise  concerns 
about  possible  imbalances  within  the  euro 
area.  In  parallel,  for  part  of  the  euro  area, 
relative  changes in  cost  competitiveness have 
resulted  in  some  rebalancing.  A  number  of 
Member  States  with  some  pre-existing  cost 
competitiveness  weaknesses, 
including  for 
example  Greece  and  Italy,  recovered  some 
ground  relative  to  their  peers  thanks  to  more 
moderate wage growth since December 2019.  

large  divergences 

The  EU  and  Member  States  introduced 
several initiatives to mitigate the impact 
the  energy  crisis  and  support 
of 
companies.  In  response  to  the  energy  crisis, 
Member States have made efforts to improve 
efficiency  and  reduce  energy  demand  and  to 
develop renewable energy. The EU reduced its 
demand  for  gas  by  17%  of  gas  between 
August  2022  and  July  2023  compared  to 
the average  of  the  previous  5  years  (21).   In 
light  of  the  economic  difficulties  faced  by 
SMEs, the SME Relief Package, adopted on 12 
September 
the 
Commission’s  commitment  to  ensuring  a 
business-friendly  regulatory  environment  that 
helps SMEs to be productive, competitive, and 
resilient (22). 
In  addition,  Member  States 
resorted  to  State  aid  to  support  specific 
sectors and companies adversely impacted by 

renewed 

2023, 

has 

(21)  Eurostat.  

(22)  See European Commission, 2023h and European 

Commission, 2023i.  

27 

FoodTextilesWoodPaperChemicalsPharmaRubber&plasticOther mineral productsBasic metalsMetal productsComputersElectrical equipmentMachineryTransport equipmentOther manuf-20-15-10-5051005101520year-on-year growth (2023-q1), %Energy intensity, % of output value 
   
 
 
 
Crisis 

(Temporary 

the energy crisis. The state aid framework was 
adapted 
Framework 
introduced  in  March  2022)  to  define  criteria 
for  the  assessment  of  the  compatibility  of 
corporate  support  with  Single  market  rules  in 
the  context  of  the  energy  crisis.  The  overall 
budget  notified  by  Member  States  and 
approved  by  the  Commission  as  part  of 
temporary  State  aid  measures  in  2022  came 
to nearly EUR671.78 billion, representing 4.3% 
of  combined  EU27  GDP  in  2022.  More  than 
half  (53%)  of  this  budget  was  approved  in 
Germany (Graph 5.5) (23).   

Graph 5.5: Granted state aid amount for 2022 
(per cent of GDP) 

(per cent  of GDP  

Source: European Commission.  

PRODUCTIVITY  

Labour  productivity  growth  has  steadily 
declined  in  the  euro  area  since  the  early 
2000s. The reasons for this slowdown remain 
a topic of scholarly  and policy debate (Lopez-
Garcia  et  al.,  2021  and  Andrews  et  al., 
2015). While  other  advanced  economies  have 
experienced  this  slowdown,  it  has  been  more 
pronounced 
to  for 
example the US. The productivity gap between 
the  two  regions  has  further  widened  for  that 
reason  (Graph  5.6).  There  is  also  substantial 

in  Europe  compared 

(23)  The amount granted are quoted in nominal terms, 

including in particular the full amount of guarantees, 
which may or may not be called upon. Information on 
the corresponding expenditures is available with a delay 
of about a year.  

28 

heterogeneity  across  euro  area  Member 
States,  suggesting  a  risk  that  economic 
divergence  could  expand  going 
forward, 
complicating the conduct of a single monetary 
policy. 

in 

deceleration 
The 

The  slowdown 
labour  productivity 
reflects  both  sluggish  investment  and  a 
of 
broad-based 
technological 
labour 
progress. 
productivity  slowdown  in  the  euro  area  is 
largely  attributable  to  the  persistence  of 
relatively  sluggish  investment  after  the  2008 
financial  crisis  (less  capital  deepening),  a 
situation  that  Europe  shares  with  the  US 
(Licchetta  et  al.,  2022a).   An 
important 
difference  between  the  two  areas  is  the 
performance 
factor 
productivity  (TFP),  where  the  euro  area  is 
lagging behind (Licchetta et al., 2022b). In the 
longer-term,  evidence  suggests  that  patents 
are becoming less disruptive (Park et al., 2023) 
and tend to require more resources to produce 
(Bloom et al, 2020).   

terms  of 

total 

in 

Graph 5.6: Labour Productivity (Index 
1995=100) 

(1) GDP per hour worked, constant prices, 2015 PPP.  
Source: OECD 

The  euro  area’s  innovation  performance 
has  been  lagging  behind  that  of  the  US 
and  Japan.  In  2021,  euro  area  countries 
spent  on  average  2.3%  of  their  GDP  on 
Research  and  Innovation  (R&I)  compared  to 
around  3.4%  in  the  US  (Graph  5.7).  Most  of 
is 
corporate  R&I  spending 

the  EU 

in 

0.00.20.40.60.81.01.21.41.61.82.0DEESNLPTLUITLTFISIMTSKHRLVFRIEELBEEECYATEA% of GDPTreaty onlyTCF onlyTotal state aid granted in 2022 for the Ukraine crisis95105115125135145155165199519971999200120032005200720092011201320152017201920211995 = 100JPUKUSEA 
     
 
  
concentrated  in  the  automotive  industry,  ICT 
products  and  services,  and  health  care 
(European Commission, 2023m). The euro area 
is  strong  on  advanced  manufacturing  and 
advanced  materials,  but  it  lags  behind  in 
critical fields, such as artificial intelligence (AI), 
big  data,  cloud  computing,  cybersecurity, 
robotics  and  microelectronics 
(European 
Commission, 2022a). Europe’s disadvantage in 
key  sectors  is  particularly  problematic  at  a 
time  when  rising  geopolitical  tensions  imply 
that technological leadership and the capacity 
for open strategic autonomy go hand-in-hand.  

Graph 5.7: Expenditure on Research and 
Innovation (% of GDP) 

innovation 

leaders  and  most 
area.  Most 
strong  innovators  appear  to  be  located  in 
Northern and Western Europe, and most of the 
moderate  and  emerging  innovators  appear  to 
be  located  in  Southern  and  Eastern  Europe 
(Graph  5.8),  which  makes  productivity 
convergence  harder  to  achieve  Similarly,  on 
the number of green patents, several Member 
States  (e.g.  Austria,  Finland  and  Germany) 
innovators,  but  multiple 
have  been  solid 
less  than  one  green 
countries  registered 
patent  per  million 
inhabitants.  Failure  to 
master  key  technologies  related  to  the  green 
transition  could  cause  structural  divergences 
between  euro  area  countries  in  the  medium-
term.  

Graph 5.8: Innovation Index 

(1) Gross domestic expenditure on R&D  
Source: Eurostat and OECD. 

Europe is lagging behind on digitalisation. 
TFP growth in Europe lagged behind the US, in 
particular in the area of ICT (manufacturing of 
computers and electronics, IT services). US TFP 
growth  in  the  ICT  sector  reached  its  highest 
level  during  2013-2019  and  the  TFP  growth 
gap  between  the  EU  and  the  US  was 
particularly pronounced during this period. The 
EU’s ICT sector accounted for 4.9% of EU GDP 
in 2021, and its share in the global ICT market 
fell  from  21.8%  in  2013  to  11.3%  in  2022. 
This has also had repercussions in other areas. 
For example, in 2022, only 69% of SMEs in the 
EU  reached  a  basic  level  of  digital  intensity 
and, in 2021, only 8% of companies in the EU 
used AI technologies.  

Innovation, 
green 
including 
technologies,  is  uneven  across  the  euro 

on 

29 

(1) Summary Innovation Index 
Source: European Innovation Scoreboard. 

There  are  significant  differences 
in 
productivity  growth  rates  also  at  the 
regional  level.  Over  the  2001-2021  period, 
many less developed regions, especially those 
located  in  the  Eastern  Member  States,  had 
above  average  productivity  and  employment 
growth, offset only slightly by a decline in the 
share  of  working-age  population,  so  that 
growth  of  GDP  per  head  was  above  the  EU 
average. This, however, masks the fact that in 
a  number  of  these  less  developed  regions, 
GDP  per  head  fell  over  this  period,  with 
productivity  falling  and  the  employment  rate 
declining 
little 
(European Commission, 2022b). 

increasing 

relatively 

or 

1.52.02.53.03.54.04.55.02012201320142015201620172018201920202021% of GDPEAUSChinaJapanSouth Korea020406080100120140160FINLBEATDELUIECYFREUEESIITESMTPTLTELHRSKLVScore 
   
   
 
 
30 

Box 5.1: Risks of geoeconomic fragmentationThe euro area economy is strongly integrated in global markets. Europe represented about 16% of the world’s trade in 2022. The euro area trade-to-GDP ratio is significantly higher today than in 2000. Conversely, trade is a critical contributor to growth in the euro area, with trade flows between the euro area and the rest of the world reached more than 60% of euro area output (Graph 1a). Two thirds of the EU’s imports are inputs, such as raw materials, that contribute to downstream activities in domestic production processes (IMF, 2023).      Geopolitical tensions and post-COVID supply chains realignments risk future adjustments of trade flows. The number of non-tariff barriers to trade has risen significantly since 2020 (Gaal et al., 2023) and countries are increasingly using foreign investment screening measures for reasons of national security (Panetta, 2023). Harmful interventions to trade increased in 2020 due to the pandemic crisis and in 2022 (Graph 1b) as a result of Russia’s war against Ukraine and the ensuing food and energy crises. These tensions have already contributed to reorienting of trade flows, in particular between the United States and China, and companies need to undertake measures to increase the resilience of supply chain in the face of geopolitical uncertainty (EBRD, 2022).  Such global trade fragmentation is likely to produce high economic costs. Recent tensions between the US and China, the COVID-19 pandemic, and the Russian war of aggression against Ukraine have put pressure on trade integration efforts. The ECB estimates that a global trade fragmentation scenario would lead to welfare losses, captured by the change in gross national expenditure, of around 1% to 2% in the euro area with losses in the euro area would be somewhat greater than those of the United States or China owing to its greater trade openness (ECB, 2023c). 01020304050607080900001020304050607080910111213141516171819202122% of GDPGraph 1a: Euro area tradeGoodsServicesGoods, excluding intra-EA tradeSevices, excluding intra-EA tradeNotes: This data consists of exports plus imports as a percentage of GDP.Source: Eurostat  010020030040050060070080010111213141516171819202122Graph 1b: Trade policy interventionsHarmfulLiberalisingSource: Global Trade Alert 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
 
 
6. SUPPORTING INVESTMENTS 

investment 

to  private 

Promoting  investment  is  at  the  core  of 
the  EU’s  recovery  strategy.  The  COVID  19 
crisis led to a sharp drop in investment, mainly 
due 
contraction. 
However,  contrary  to  the  aftermath  of  the 
global  financial  crisis,  investment  rebounded 
fast  after  the  COVID-19  pandemic  (Graph 
6.1).  This  was  linked,  in  particular,  to  the 
supportive  monetary  stance,  to  the  resilience 
of  financial  markets  and  to  a  decisive  policy 
reaction to support public investment.  

Graph 6.1: Investment sectoral breakdown, 
euro area (volumes, 2019 = 100) 

(1) public and private investment volumes are calculated 
based on total investment deflator 
(2) public investment includes aggregates of general 
government GFCF and GFCF financed with RRF grants 
Source: European Commission 

financial 

tightening 

Private  investment  is  slowing  down  due 
to 
conditions. 
Following the series of sharp policy rates hikes 
by the ECB (see Section 2), financial conditions 
credit 
tightened 
dynamics.  Most  of  enterprises  expect  further 
worsening  of  their  access  to  bank  financing 

significantly, 

affecting 

and  credit  lines (24).  The  impact  is  particularly 
strong  for  construction  investment,  as  tighter 
financing  conditions  are  compounded  by  a 
drop 
in  demand  given  the  downturns  in 
housing markets.  

Policies to support investment 

Graph 6.2: Public investment in 2019 and 2023 
by financing source 

Source: European Commission 

The Recovery and Resilience Facility (RRF) 
and  cohesion  policy  funds  provide  a 
substantial  boost  to  public  investment 
and 
implementation  should  continue 
without delays. The RRF, which is part of the 
Next  Generation  EU  (NGEU),  makes  available 
EUR  723  billion  to  support  investment  and 
reforms.  Two  years  into  implementation,  the 
RRF  has  contributed  to  the  recovery  in  public 
investment  (Graphs  6.1  and  6.2),  including 
deployment  of  green  technologies,  modern 
digital  infrastructures,  as  well  as  green  and 

(24)  28th Survey on the Access to Finance of Enterprises 

(SAFE), ECB 2023. 

31 

8085909510010511011512012513020192020202120222023202420252019 = 100Total economyPublic investmentPrivate investment01234567SIFILVEELUFRATNLHRBESKLTITCYDEESMTPTELIEEA% of GDPEU funds 2023, other than RRFRRF 2023Nationally financed investment 2023Nationally financed investment 2019Public investment 2019 
 
   
   
 
digital and skills development. The RRF is also 
expected to crowd-in more private investment 
(Pfeiffer et al. 2023). Although Member States 
are on track with their recovery and resilience 
plans, some - particularly Member States with 
very large  allocations  -  are  lagging  behind  on 
grant  absorption. 
(European  Commission, 
2023j).  Cohesion  policy  funds  are  also  a 
crucial  source  of  public  investment  funding. 
While  Member  States  are  finalising 
the 
implementation  of  the  2014-2020  funds,  in 
2021-2027,  an  additional  EUR  392  billion  is 
available  to  invest  in  the  green  and  digital 
transitions. The implementation of these funds 
has  started  to  pick  up  pace  with,  however, 
certain challenges.   

Graph 6.3: Perception of long-term barriers to 
investment (% of EU firms) 

(1) Survey answers for question: "Thinking about your 
investment activities, to what extent is each of the 
following an obstacle? Is a major obstacle, a minor 
obstacle or not an obstacle at all?" 
(2) Data for all surveyed firms from all sectors; data for 
answers for "no obstacle" and "don't know/refused" are 
not shown. 
Source: European Investment Bank Investment Survey 
(EIBIS) 2023 

public 

private 

Persisting obstacles weigh on investment, 
both 
ones. 
and 
Administrative  hurdles,  linked  in  particular  to 
permitting,  undermine  investment,  particularly 
for  projects  related  to  the  green  transition.  In 
regardless  of  size, 
addition,  enterprises, 
consider  the 
labour  and 
lack  of  skilled 
increasing production costs to be among their 
biggest  concerns  (Graph  6.3) 
(European 
Investment Bank, 2023a). Such obstacles limit 

the  ability  of  firms  to  invest,  and  therefore 
have an impact on potential growth. They also 
impede  a  successful  roll  out  of  RRPs  and 
cohesion  policy  funds.  Accordingly,  the  2023 
revision  of  the  euro-area  Member  States’ 
plans aim to introduce additional reforms and 
investments, which are set to address specific 
regulatory hurdles and investment bottlenecks 
identified  in  the  RRPs  implementation  so  far 
(European Commission, 2023j). 

Supporting the Green transition 

to 

need 

transition 

accelerate 

In  the  context  of  the  energy  crisis  and 
the 
net-zero 
industries,  major  EU  trading  partners 
have  taken  action  to  support  investment 
in such technologies. The success of Chinese 
global firms as producers of goods needed for 
the  green 
(e.g.,  solar  panels, 
batteries,  electric  vehicles,  wind  turbines)  is 
fundamental  cost 
surely  determined  by 
advantages  but  also  the  extensive  use  of 
government subsidies (Springford and Tordoir, 
2023) Another key policy factor in this respect 
relates  to  different  degrees  of  ambition  of 
environmental  policy  across  world  areas.  The 
approach  to  address  climate-related  issues 
chosen  by  the  EU  has  centred  on  emission 
pricing  and  flanked  by  a  variety  of  measures 
to  support  the  development  and  deployment 
of green technology. Since the adoption of the 
in  2022,  the  US 
Inflation  Reduction  Act 
approach  has  been  based  mainly  on  large-
scale  subsidies  to  green  technologies.  While 
the  jury  is  still  out  given  the  short  timeframe 
since  IRA  adoption,  such  policy  differences 
could have implications for competitiveness on 
a  global  scale,  potentially  leading  to  price 
pressures 
industry  abroad 
(Clausing and Wolfram, 2023).  

relocate 

to 

Support for industries that are critical to 
the  green  transition  is  essential  even 
though it entails some risks. Policy actions 
to support the green transition range from an 
acceleration  of  permitting  and  administrative 
procedures  to  industrial  policy  tools  such  as 
public  subsidies  and  public  procurement  rules 
that  introduce  (within  limits)  a  preference  for 
domestic production. Industrial policy has been 

32 

0%10%20%30%40%50%60%70%80%90%100%Availability of staffwith the right skillsEnergy costsUncertainty aboutthe futureBusiness regulationsand taxationDemand for productor serviceLabour marketregulationsAvailability of adequatetransport infrastructureAvailability of financeAccess to digitalinfrastructure% of EU firmsMajor obstacleMinor obstacle 
   
circular 

Incentivising 

shown  to  be  a  powerful  tool  to  complement 
carbon pricing and ensure a speedy  and cost-
effective  way  to  boost  innovation  and  rapidly 
shift  towards  climate  neutrality  (Acemoglu  et 
al.,  2012).  Strengthening  “strategic”  industries 
that  are  considered  critical  for  the  net-zero 
transition  of  the  economy  is  needed  to  avoid 
developing  excessive  dependencies  from  non-
EU  suppliers,  while  providing  also  a  response 
to  initiatives  to  subsidise  green  technologies 
by  other  major  world  regions,  including  China 
and the US (Inflation Reduction Act) (European 
Commission  2023k  and  Tagliapietra  et  al., 
2023). 
economy 
approaches in industry is also crucial to further 
reduce  both  greenhouse  gases  and  other 
resource 
pollutants’ 
efficiency  and  reduce  critical  dependencies, 
thus  strengthening  the  EU’s  resilience  and 
competitiveness.  Nonetheless,  while  industrial 
policy  is  an  important  tool,  it  should  not  be 
seen  as  a  panacea  towards  sustainable 
growth,  notably  because  it  will  carry  some 
downsides  at  the  domestic  and  international 
level  (Terzi,  2023).  On  the  domestic  side,  if 
industrial  policy  is  not  well  designed  (Terzi  et 
al., 2022), it is at risk of reducing competition 
and  consequentially  the  rate  of  innovation, 
leading to higher prices for consumers. On the 
international  side,  a  costly  subsidy  race 
between  major  economies  could  lead  once 
increasing  price  and  budgetary 
again  to 
pressures.  

emissions, 

boost 

revision  of 

the  March  2023 

The use of state aid to support strategic 
sectors  carries  important  risks  to  the 
single  market  and  may  aggravate 
divergences  within  the  euro  area.  In  line 
with 
the 
Temporary  Crisis  and  Transition  Framework 
(TCTF),  a  number  of  countries  are  using  state 
aid  to  support  the  green  transition.  However, 
the  greater  reliance  on  state  aid  at  national 
level  runs  the  risk  of  destabilising  the  level 
playing  field  within  the  single  market  and 
missing  the  opportunity  of  fully  exploiting 
economies  of  scale  at  the  EU  level.  Absent 
some coordination in industrial strategy, larger 
Member  States  or  those  with  greater  fiscal 
space  may  have  greater  scope  to  support 
companies,  to  the  partial  detriment  of  other 
euro  area  countries  and  the  integrity  of  the 
the 
European  Union.  For 

reason, 

that 

33 

via 

technologies 

Commission  put  in  place  the  Innovation  Fund 
to  support  the  demonstration  of  innovative 
low-carbon 
EU-wide 
competitive  calls  for  large-scale  and  small-
scale  projects.  The  Commission  has  been 
arguing  further  in  favour  of  a  European 
mechanism  to  support  companies  (Strategic 
Technologies  for  Europe  Platform,  STEP)  and 
has taken measures to ensure the resilience of 
supply  chains, 
including  for  Critical  Raw 
Materials  that  constitute  a  crucial  input  to 
green technologies. 

Developing capital markets 

Graph 6.4: Size of the different markets in 
terms of GDP 

(1) 2021, latest available data 
Source: Eurostat and OECD 

in 

the 

euro 

Companies 
area 
predominantly  use  bank  loans  and  their 
use  of  market-based  finance  remains 
limited.  Loans  represent  close  to  26  %  of 
total  liabilities  of  non-financial  corporations 
while  the  share  of  tradable  instruments  (debt 
securities  and  listed  equity)  stands  at  21 %. 
Market-based  funding 
in 
Canada,  the  United  Kingdom  and  the  United 
States,  where  it  stands  at  34 %,  38 %  and 
45 %, respectively (Graph 6.4). The difference 
can partly be explained by a high share in the 
euro  area  of  small  and  medium  enterprises 
(SMEs)  and  family-owned  businesses,  which 
are  financed  predominantly  through  loans.  As 

is  much  higher 

050100150200250300350EAUKCAUS%Listed sharesDebt securitiesLoans 
   
a  result,  the  size  of  capital  markets  (equity 
and debt securities) in the euro area is smaller 
than  that  of  other  large  economies.  In  2021, 
loan  liabilities  in  the  euro  area  represented 
229 %  of  GDP,  while  debt  securities  were 
169 %  of  GDP,  and  listed  shares  represented 
(Graph  6.5).  By 
only  82 %  of  GDP 
comparison, 
loans 
represent  156 %  of  GDP,  while  listed  shares 
and debt securities are respectively 254 % and 
223 %.  

the  United  States, 

in 

Graph 6.5: NFC's share of liabilities by 
different types 

(1) 2021, latest available data 
Source: Eurostat and OECD 

In  addition,  capital  markets  in  the  euro 
area 
the 
remain  fragmented  along 
national  lines.  On  average  in  the  euro  area, 
78 %  of  equity  and  49 %  of  debt  securities 
held  by  investors  are  issued  in  the  same 
Member  State.  Such  a  large  home  bias  in 
security  holding  leads  to  disparities  in  capital 
costs and obstacles with respect to the access 
to financing across the euro area. It results in 
higher  financing  costs  for  companies  and 
curtails potential returns for investors. Another 
sign  of  fragmentation  is  the  large  number  of 
national  and  regional  stock  exchanges  that 
continue  to  coexist  in  the  EU,  more  than  30 
compared to only a few in the United States.  

The Capital Market Union agenda aims at 
reducing 
increasing 
fragmentation, 
access to finance and, in turn, supporting 
competitiveness. 
innovation 
lower 
imply 
Fragmented  capital  markets 

and 

34 

for 

shows  a 

opportunities 

funding.  Evidence 

competition  among  financial  institutions,  high 
liquidity  premia,  and  eventually  a  higher  cost 
of 
strong 
correlation  between  access  to  capital  market 
and cost of funding (Graph 6.6). Stronger and 
increase 
integrated  capital  markets  can 
financing 
innovative 
companies  that  are  often based  on intangible 
capital  and  have  comparatively  little  physical 
collateral 
The 
development  of  innovative  companies,  and  in 
particular  start-ups,  is  therefore  particularly 
dependent on the existence of well-developed 
capital  markets.  In  particular,  venture  capital 
funds play a central role by supporting young, 
fast-growing companies. In the last ten years, 
investments  have  slowly 
venture  capital 
increased 
in  the  euro  area  but  remain 
significantly  below  those  in  the  United  States 
(Graph 6.7). 

secure 

bank 

loan. 

to 

Graph 6.6: Correlation between cost of 
borrowing for firms and the share of NFC's 
listed equities and debt security over total 
NFC's liabilities 

Source: ECB and OECD 

In  September  2020,  a  new  CMU  Action 
Plan was rolled out. The plan sets out three 
to  make  financing  more 
key  objectives: 
for  European 
in 
accessible 
citizen’s 
particular 
SMEs, 
confidence  and  participation 
capital 
markets,  and  to  integrate  national  capital 
markets into a genuine EU-wide single market 
for capital. The Commission has now delivered 
on all of the 16 actions included in the plan.  

companies, 

increase 

to 

in 

0%10%20%30%40%50%60%70%80%90%100%CYLVSKEEMTLTSIHRPTBEESITELATLUFRNLDEIEFIEA20UKCAUSDebt securitiesListed sharesUnlisted sharesOther equityOthersLoans 
   
 
 
Stronger capital markets can enhance the 
international  role  of  the  euro.  The  euro’s 
global  role  remained  resilient  during  the 
pandemic  and  despite  Russia’s  aggression 
towards  Ukraine  (ECB,  2023d).  The  euro  has 
consolidated  its  position  as  the  second  most 
used 
international  currency.  However,  the 
euro´s  global  role  continues  to  punch  below 
the euro area’s economic and financial weight. 
In that respect, a deeper EMU, supported by a 
more integrated and better functioning Capital 
Markets  Union  would 
the 
international role of the euro. 

strengthen 

Graph 6.7: Venture capital investments as a 
share of GDP (stock) 

Source: OECD 

35 

 
 
 
 
 
 
ANNEXES 

 
 
 
 
CROSS-CUTTING PROGRESS INDICATORS 
ANNEX 1: SUSTAINABLE DEVELOPMENT GOALS 

Graph A1.1: Progress towards SDGs in the European Union 

Data based on EU progress as consolidated data for the euro area is not available  
Source: Eurostat 

put  in  place  the  policy  measures  to  deliver  these 
additional  efforts,  notably  via  the  ‘Fit  for  55’ 
package,  with  a  revision  of  the  EU  emissions 
trading  system  (ETS),  and  the  Effort  Sharing 
Regulation  that  sets  binding  annual  greenhouse 
gas  emissions  targets  for  Member  States.  In  the 
area  of  energy,  the  EU  has  also  set  more 
ambitious  targets  for  2030.  This  implies  that 
stronger  progress  is  expected  to  be  visible  in  26 
the coming years in the area of energy efficiency 
and  renewable  energies  in  the  EU,  as  well.  51 
Concerning  life  on  land  (SDG  15),  even  though 
terrestrial  protected  areas  have  increased  since 
2013, the EU continues to face steady declines in 
common  bird  and  grassland  butterfly  populations. 
Additional  efforts  needed 
the 
degradation  of  ecosystems  are  envisaged  in  the 
EU  2030  Biodiversity  Strategy,  in  the  EU  forest 
strategy for 2030 launched this year and in the EU 
Soil  Strategy,  which  sets  a  2030  objective  on 
restoring  degraded  land  and  soil  and  combatting 
desertification.  Regarding  partnerships  for  the 
goals (SDG 17), the trend partially reflects cyclical 
effects  and  notably  the  increase  in  public  debt 
resulting from the COVID-19 crisis. 

reverse 

to 

Over  the  last  five-year  period,  the  EU  has  made 
significant progress towards ensuring decent work 
and  economic  growth  (SDG  8)  and  reducing 
poverty  (SDG  1).  Significant  progress  has  also 
been  made  towards  achieving  gender  equality 
(SDG  5).  Good  but  more  moderate  progress  has 
also been achieved towards the goals on reducing 
inequalities  (SDG  10),  ensuring  quality  education 
(SDG  4),  fostering  peace  and  personal  security 
within  the  EU’s  territory  and  improving  access  to 
justice  and  trust  in  institutions  (SDG  16),  health 
and  well-being  (SDG  3),  despite  the  setbacks 
caused  by  the  COVID-19  pandemic,  and  on 
innovation  and  infrastructure  (SDG  9).  Progress 
towards  the  remaining  goals  -  zero  hunger  (SDG 
2),  clean  water  and  sanitation  (SDG  6)  and 
affordable  and  clean  energy  (SDG  7)  -  has  been 
less significant.  

More  progress  is  expected  for  three  goals  – 
climate action (SDG 13), life on land (SDG 15) and 
global  partnerships  (SDG  17)  –  as  EU  Member 
States  are  set  to  implement  the  higher  level  of 
ambition  in  the  environmental  targets  set  at  EU 
level.  Regarding  climate  action  (SDG  13),  the  EU 
has  set  very  ambitious  and  unparalleled  climate 
targets for 2030 and, as compared to past trends, 
they will require more efforts. The EU has already 

38 

 
 
 
 
ANNEX 2: PROGRESS IN EARS IMPLEMENTATION 

Graph A2.1: Implementation of EAR-relevant Country Specific Recommendations (CSRs) 

(1) Analysis at sub-CSR level. Sub-CSRs for 2019, 2020 and 2022 are grouped according to 2023 EARs. 
Source: European Commission analysis based on CeSaR Database 

taken 

recommendations 

The  implementation  of  the  2023  euro  area 
recommendations  (EARs)  can  be  assessed 
through  the  progress  on  the  relevant 
(CSRs). 
country-specific 
Euro  area 
into 
recommendations  are 
account  when  addressing  CSRs  to  euro  area 
Member  States  in  the  context  of  the  European 
Semester.  The  country  recommendations  are 
tagged 
addressing 
EAR-relevant  when 
challenges  which  are  also  important  for  the  euro 
area  as  a  whole.  Accordingly,  progress  in  the 
implementation  of  EAR-relevant  CSRs  of  recent 
Semester  cycles  (2019  –  2022)  provides  an 
estimate  of  the  degree  of  implementation  of  the 
EARs.  As  regards  the  2023  EARs,  the  number  of 
EAR-relevant  sub-CSRs  varies  regarding  different 
EARs,  with  a  clear  focus  on  green  and  digital 
transitions, as well as the labour market. 

as 

extent  linked  to  the  rollout  of  investment  under 
the euro area Member States’ RPPs. Similarly, the 
CSR regarding reforms on labour market, including 
wages  developments  and  social  policy  (EAR  3), 
show  an  overall  good  progress.  However,  reforms 
in  those  areas  are  generally  slow  and  only  15% 
have  recorded  substantial  progress  over  the  last 
  Recommendation  on  corporate 
three  years. 
support  (EAR 4)  have  been  made  in  relatively 
fewer  countries.  However,  they  have  generally 
been well implemented. These relate in general to 
liquidity support for companies, in particular small 
and  medium-sized  enterprises,  and  measures 
related  to  business  environment.  Relatively  few 
sub-CSRs  respond  to  the  EAR 5  (the  macro-
financial  stability,  monitoring  banking  asset 
quality,  non-performing  loans,  the  completion  of 
the Banking Union and work on the digital euro). 

Overall,  the  implementation  of  EAR-relevant 
CSRs  shows  some  progress,  but 
the 
implementation  varies  across  policy  areas 
(Graph  A2.1).  While  the  CSRs  related  to  fiscal 
policy 
(EAR 1)  generally  show  a  moderate 
progress,  the  measures  linked  in  particular  to 
sustainability  of  public  finances  (e.g.  pension 
reforms) present a lower level  of implementation.  
A relatively large number of CSRs address the EAR 
2,  on  investment  for  the  twin  transitions  and 
the  sub-CSR 
energy 
relevant  for  EAR  2  show  some  progress  in 
implementation  (60%  of  sub-CSRs),  while  only 
14%  record  “full  implementation”  or  “substantial 
progress”.  The  progress  in  EAR  2  is  to  a  large 

independence.  Most  of 

39 

0%10%20%30%40%50%60%70%80%90%100%EAR 1EAR 2EAR 3EAR 4EAR 5Full ImplementationSubstantial ProgressSome ProgressLimited ProgressNo Progressnumberof relevant sub-CSRs32200954713 
 
 
  
ANNEX 3: CONTRIBUTION OF THE RRF TO THE EURO AREA PRIORITIES 

chapters,  may  have  delayed  the  disbursement 
schedule in some Member States. 

Graph A3.2: Progress in investment milestones and 
targets in euro area RRPs 

The  implementation  of  the  RRF  is  set  to 
increase  growth  potential  and  contribute  to 
income  convergence  in  the  euro  area.  The 
RRF’s positive impact on the economy is expected 
to come both from higher investment, with crowd-
in  of  private  investment (Pfeiffer  et  al.,  2023),  as 
well as through the increase in productivity derived 
from  structural  reforms  planned  in  the  national 
recovery  and  resilience  plans  (Bankowski  et  al., 
2022).  

Graph A3.1: Progress in reform milestones and 
targets in euro area RRPs 

(1) Numbers reported relate to the number of milestones and 
targets planned for a given year. 
(2) The “initial” schedule corresponds to the content of the CID 
annex. The “current” schedule is based on bi-annual reporting 
by Member States. 2025 and 2026 are outside the scope of 
the reporting. 
Source: European Commission 

The implementation of national RRPs appears 
to be broadly on track. By mid-November 2023, 
received  34  payment 
the  Commission  has 
requests  from  19  euro  area  Member  States  and 
disbursed a total amount of EUR 162.1 billion. This 
is around 40% of the RRF funds committed to the 
euro  area  Member  States,  with  EUR  51.6  billion 
paid  in  pre-financing  and  EUR  110.5  billion  of 
grants and loans paid after milestones and targets 
were reached]. Based on the Members States self-
reporting,  delays  in  investment  and  reforms  are 
limited so far (Graph A3.1 and A3.2). Still, some 
in 
Member  States  are 
limited 
administering  funds,  due, 
investment 
administrative 
capacity 
bottlenecks (European 
2023j). 
Revisions  in  RRPs, in  particular  to  add  REPowerEU 

or 
Commission, 

in  part,  to 

challenges 

facing 

(1) Numbers reported relate to the number of milestones and 
targets planned for a given year. 
(2) The “initial” schedule corresponds to the content of the CID 
annex. The “current” schedule is based on bi-annual reporting 
by Member States. 2025 and 2026 are outside the scope of 
the reporting. 
Source: European Commission. 

Investment and reforms included in recovery 
and  resilience  plans  are  set  to  contribute  to 
euro  area  priorities.  Mapping  the  various 
investments  and  reforms  planned  in  the  RRPs 
against  the  euro  area  recommendations  of  2023 
shows  that  about  40%  of  the  milestones  and 
targets  corresponding  to  reforms  planned  over 
2021-2026  respond  to  the  EAR  2023  (Graph 
A3.1).  For  investment,  this  ratio  is  close  to  44% 
(Graph  A3.2).  More  in  detail,  the  various  policy 
areas addressed in the EAR 2023 are covered in a 
heterogeneous manner. The EAR 1, on fiscal policy, 
is addressed through measures to increase quality 
and  sustainability  of  public  spending, in  particular 
on healthcare and pension. EAR 2 on investment is 
extensively  covered  by  the  measures  planned. 
Labour  market  reforms,  which  correspond  to 
EAR 3,  are  addressed 
through 
measures to improve active labour market policies, 
address  skills  shortages  and  promoting  quality 
employment.  By  comparison,  EAR  4  and  5, 
respectively  on  the  business  environment  and  on 
macro-financial  stability,  are  less  addressed  in 
RRPs, although in some cases measures have been 
taken outside RRPs.  

in  particular 

40 

212212611518015712114875816262515128241761662662431962231231311241258384InitialReportedInitialReportedInitialReportedInitialReportedInitialReportedInitialReportedInitialReported2020202120222023202420252026Euro area relevant investmentsOther investments5510497231206237250182202266265228228458283263234268275256266362368337341InitialReportedInitialReportedInitialReportedInitialReportedInitialReportedInitialReportedInitialReported2020202120222023202420252026Euro area relevant investmentsOther investments 
 
   
   
ANNEX 4: KEY ECONOMIC AND FINANCIAL INDICATORS 

Table A4.1: Main macroeconomic indicators of the euro area 

Source: European Commission, autumn 2023 forecast 

41 

bn EURCurr. prices% GDP04-1920202021202220232024202513491.3100.01.2-6.15.93.40.61.21.67062.552.31.0-7.84.44.30.61.21.52899.221.51.31.14.21.60.21.00.93019.522.41.4-6.23.82.61.21.32.07435.655.14.0-9.011.27.20.22.23.17192.153.33.8-8.69.07.9-0.32.33.013529.5100.31.3-6.66.92.70.51.31.41.1-5.34.03.10.61.11.40.0-0.30.70.3-0.30.00.00.2-0.51.3-0.10.30.00.20.7-1.41.42.31.10.50.5Unemployment rate (a)10.28.07.76.86.66.66.42.11.02.64.15.54.53.41.44.6-0.23.46.03.82.312.719.617.513.714.514.514.41.41.82.24.65.93.02.41.60.32.68.45.63.22.2-0.11.6-3.2-6.34.40.20.22.03.32.70.21.92.02.21.72.33.61.02.52.62.7-2.6-7.1-5.2-3.6-3.2-2.8-2.7-0.9-3.7-4.5-4.0-3.2-2.8-2.883.299.196.592.590.489.789.5Structural budget balance (d)General government gross debt (c)(a) as % of total labour force. (b) gross saving divided by adjusted gross disposable income.  (c) as a % of  GDP. (d) as a % of  potential GDP.Harmonised index of consumer pricesTerms of trade goodsTrade balance (goods) (c)Current-account balance (c)General government balance (c)EmploymentCompensation of employees / headUnit labour costs whole economySaving rate of households (b)GDP deflatorDomestic demandInventoriesNet exportsGross fixed capital formationExports (goods and services)Imports (goods and services)GNI (GDP deflator)Contribution to GDP growth:2022Annual percentage changeGDPPrivate ConsumptionPublic Consumption 
 
 
 
  
 
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