guy quaden : the outlook for the european economy, the turmoil in financial markets and monetary policy remarks by mr guy quaden, governor of the national bank of belgium, at a business dinner, dubai, 31 october 2007. * * * i thank you very much for your invitation to this business dinner. i am very pleased to have the opportunity to spend a few days in the united arab emirates, one of the most quickly developing regions in the world and in my eyes one of the most fascinating places to be. i will present some remarks about the outlook for the european ( eurozone ) economy, the consequences of the turmoil in financial markets ( but not about the causes of the turbulence and the first lessons to be drawn : it will be the subject of another speech ) and the stance of the monetary policy. the latest news from europe is not bad. 2006 was an excellent year and prospects for this year and next year remain positive. however the uncertainty surrounding these prospects has increased. the world has been experiencing a fairly long period of economic good times. for a few years the strong activity has been driven only by the united states and the emerging markets whereas europe seemed to stand back. however the pace of global economic activity has become more balanced across the main economic regions. after having gone through a protracted period of subdued growth and short - lived recoveries, europe was in the upswing of a cycle since early 2005, backed in particular by the longawaited recovery in the largest economy of the zone, germany. in 2006, real gdp expanded by 2. 9 % in the eurozone, twice the rate recorded in the previous year. investment increased by 5. 2 % and private consumption also picked - up. gross exports rose by an impressive 8. 2 %. however the contribution of net exports to gdp growth was relatively moderate ( 0. 3 % ) because imports also rose significantly. therefore last year gdp growth in the eurozone was mainly driven by the faster increase in domestic demand, sustained in particular by a steady improvement in the labour market. the number of employed people rose by around 2 million ( 1. 4 % ) and the unemployment rate dropped in 2007 to the lowest level since 1993. moderate wage developments have also contributed to stronger employment growth. that said, the level of unemployment in the eurozone ( close to 7 % ) is still high in comparison with other regions and there remain inefficiencies and rigidities in labour markets to be tackled through further structural reforms. until this

of discipline can have on the climate of confidence. it seems that people in europe more and more have a “ ricardian perception ” of fiscal deficits. they are more aware of the enormous challenges and costs our ageing society entails. people in the different european countries are really worried about the long - term sustainability of public finances. high fiscal deficits will only worsen their anxiety and so incite them to increase their precautionary savings. in this context, the rules of the stability and growth pact are appropriate. it is not correct to describe it as a fiscal straitjacket. starting from a budget in balance or in surplus at the peak of the cycle, a country can let the automatic stabilisers fully operate when the activity is slowing down. the main problem with the pact is, i think, that better incentives are needed to respect fiscal discipline during good economic times. so i hope that the forthcoming recovery will be the right moment for the european governments now facing budgetary difficulties, to put their finances again on the right track, so that in that field it will be possible to reconcile short time flexibility with long term sustainability. in that case fiscal policy may again become an element of the required lasting macroeconomic stability. it is by paying more attention to the quality of public finances and by rendering the structure of taxes and that of expenses more growth oriented that governments can contribute to stimulating europe ’ s growth potential. i refer to expenditures such as education and improvement of human capital, public investment in infrastructure and research and development. r & d could become a comparative advantage of europe. at the moment europe invests 1. 9 p. c. of gdp in r & d and is thus lagging behind the us figures and the lisbon target ( 3 p. c. ). over the past years, european policymakers have become more aware of this growth problem europe is facing. so, in march 2000, during the lisbon summit, an ambitious strategy was adopted aiming to increase the rate of sustainable economic growth and even to enable europe to become the most competitive and dynamic knowledge - based economy in the world in 2010. in order to achieve such a strategic goal the lisbon agenda has brought together the different strands of reform policies on product, labour and capital markets aiming at promoting a more efficient allocation of resources and at higher growth potential. moreover, in order to facilitate monitoring of progress with reforms, quantitative targets have been fixed to measure progress in particular on the labour market in achieving for instance higher