Quarterly report on the euro area says headwinds gather strength

The economy has to contend with strengthening external headwinds but the euro area is showing resilience helped by strong growth in emerging markets, shows the latest Quarterly Report on the Euro Area (QREA). The most recent hard and soft data are consistent with the growth forecast announced on 21 February. The Report also looks at why growth and inflation have become more stable in industrialised countries in recent decades, a phenomenon economists refer to as the 'Great Moderation'. It shows that labour market reforms have succeeded in increasing employment levels but that there is a growing divide on the labour market, with the burden of reform falling on those not subject to standard labour contracts. It also shows that the economies of the Member States are reacting differently to the ongoing inflationary pressures. Finally, in its focus section, the QREA argues that East Asia could take inspiration from the European economic and monetary experience to the benefit of the region and indeed the whole world.

Euro area GDP growth decelerated from 2.6% year-on-year in the third quarter of 2007 to 2.2% in the fourth quarter. This deceleration owes much to a weakening of private consumption on the back of surging consumer prices. In February 2008, inflation was running at 3.3%, up from 1.7% in the summer of last year. However, continued strong growth in investment supported by high capacity utilisation and the high profitability of the non-financial corporate sector is encouraging. According to the Commission’s interim forecast of February 2008, economic growth in the euro area is expected to slow down to 1.8% for 2008. This is borne out by the hard and soft data released since. Confidence indicators in the manufacturing sector have generally held up relatively well in recent months and the latest reading of industrial production was stronger than expected.

The report also examines the more stable inflation and growth rates experienced by the euro area, like most industrialised countries, over the past two to three decades. This 'Great Moderation' is not just due to luck in the form of milder shocks, but also improvements in economic policies, in particular better monetary policy and, to a lesser extent, more powerful automatic fiscal stabilisers. Changes in economic policies have been a particularly important driver of moderation in countries where policy mistakes were particularly acute before.

The Quarterly Report on the Euro Area - QREA also looks at recent labour market reforms in the euro area. The reforms have mainly aimed at increasing labour utilisation, especially in groups with low participation rates, such as the low-skilled, women and older workers. Evidence shows that reforms have paid off, raising employment rates and enabling employment to respond more effectively to cyclical shocks. However, additional measures may be required to tackle the growing divide in the euro-area labour market with reforms concentrated in the margins of the labour market while standard labour contracts are spared.