Monetary policy must remain in place in times of turmoil

Nils Thigesen, Royal Bitsma, Massimo Bordiganon, Javier Debrun, Mateus Szczurek, Martin Larch, Matthias Buse, Mateja Gabrijelsic, Lazlo Jankovic, Janice Malzubris June 27, 2022

The war in Ukraine has clouded the near-term economic outlook. However, the European Fiscal Board concluded that the current policy plans for 2023 amount to a broadly appropriate financial position for the euro area as a whole. Despite the war a moderate financial contraction seems adequate. Indeed, the terms of trade extended by the war are an overall income loss amount that cannot be buffered by additional public debt savings. A revenue stimulus would also undermine the ECB’s efforts to better align overall demand with overall supply to control inflationary pressures. Instead, monetary policy should focus on targeting and providing temporary assistance to vulnerable households without predicting medium-term debt sustainability.

The war in Ukraine has clouded the near-term economic outlook. Following the severe recession caused by the Covid-19 epidemic, the eurozone economy was set to continue to recover strongly by 2023. In its latest forecast, the European Commission said economic activity in the euro area is low but will still rise strongly (slightly above the pre-epidemic average), while negative risks have intensified.

Despite the weak outlook, actual output in the Eurozone and the EU should already exceed the 2019 level in 2022 and is expected to continue in 2023. The Commission’s spring forecast assumes that the output gap will close in 2023 or be slightly positive. , The unemployment rate will fall to 7%, the lowest rate since the adoption of the euro. Meanwhile, the headline inflation of the ECB project will come down from the peak of 2022 to about 3.5% in 2023 (ECB 2022), a benign scenario in the light of repeated reversals in recent months. If inflation persists longer than expected, the risk of the wage-price spiral igniting will increase significantly and with it the financial situation is likely to strengthen significantly.

Figure 1

A) Real GDP recovery in Eurozone (2019 = 100)

Formula: European Commission

B) Euro area unemployment rate

Formula: European Commission
Note:: NAWRU refers to the non-accelerated wage rate of unemployment.

Evaluation of the suitability of the financial position of the Eurozone in 2023

Withdrawal of financial aid is expected to continue in 2023, as governments phase out epidemic-related emergency measures and gradually rebuild the buffer. Under current policy, the eurozone’s revenue position (i.e. structural primary deficit) is expected to stand at 1.3% by 2023, up 0.7 percentage points from GDP. Thus, pending the formulation and adoption of the government budget for 2023, the revenue trend (i.e. change in structural initial balance) is expected to be moderately limited for the second year in a row. The overall financial position will still be helpful. Possible new prudent measures in response to the war, including protecting the purchasing power of at-risk groups, have not yet been fully reflected in this forecast.

The war intensified the deterioration of trade conditions that began in mid-2021. Faced with limited options for shifting away from energy and food imports, the eurozone economy has suffered a large revenue loss and more severe supply constraints. At the same time, aggregate demand (personal use and investment) was strong behind the post-epidemic momentum, feeding on domestic inflationary pressures. Against this background, stimulus demand can only prove unfavorable and drive ECB’s efforts to better align supply and demand.

As a result, the EFB considers a moderately restricted revenue incentive to be appropriate in 2023. Current revenue policies are largely consistent with this recommendation. This does not mean that we should not respond to the push of fiscal policy. Governments can and should take targeted and temporary measures aimed at reducing the costs of vulnerable households, in addition to pursuing fiscal consolidation. This requires effective spending priorities to preserve nationally funded public investment.

Figure 2

A) The euro zone’s financial trends over time

B) Financial trends, cyclical situation and sustainability across member states in 2023

Formula: European Commission.
Note:: Fiscal impulses include the effects of RRF grants (based on cash disbursements).

Faced with an uncertain outlook, fiscal policy must remain agile without sacrificing medium-term debt reduction. During the epidemic, government debt ratios rose in most member states, pushing the eurozone debt-to-GDP ratio above 100%. Still low sovereign debt costs, solid economic growth and high inflation are temporarily relieving the pressure on the debt ratio. Yet nominal growth is set to normalize when the cost of marginal borrowing by the government in most member states by the end of 2021 has already reached 200 basis points. The EFB agrees with the Commission on the need to move to prudent revenue positions and to keep government debt firmly on the downward path, especially in high-debt countries. It will achieve a well-coordinated mix of revenue and fiscal policy, while rebuilding the revenue buffer.

Continued application of the severe economic downturn

Contrary to previous announcements, the severe recession clause will still apply in 2023 (European Commission 2022b). The Commission had earlier communicated that the decision to continue implementing the clause would be based on an overall assessment of the level of economic activity in the EU or Eurozone compared to the pre-crisis level (end-2019). The main criterion. This criterion has already been met by 2022 and the war in Ukraine is not expected to change that. However, the Commission argued in May 2022 that the economy had not returned to ‘normalcy’, and that considerable uncertainty surrounding the outlook justified an extended application of the clause.

This has implications for pursuing a suitable euro zone financial position. As this clause remains in force, the Commission has again issued broader country-specific guidelines for member states for 2023 (European Commission 2022a). Some broader goalposts were given to ‘high debt’ and ‘low / medium debt’ countries, mostly about nationally financed current spending increases. However, the guidelines do not allow for the adoption of any clear recommendations on the overall financial trends for the eurozone as a whole. In the absence of quantitative recommendations anchored in agreed revenue rules and procedures, it is unlikely to provide a suitable euro zone financial position.

The decision to implement the clause in 2023 on the basis of a new economic rationale emphasizes the broad prudence available to the Commission. Such prudence, when the Stability and Growth Agreement itself is subject to scrutiny for reform, precisely reduces the predictability of the financial trajectory when the increase in policy uncertainty is undesirable. The EFB is looking forward to the Commission’s adaptation of a possible review of EU economic governance scheduled for autumn this year and how it intends to implement existing rules if it fails to reach an agreement on key elements of the EU’s political leadership. A timely legal reform for the next round of country-specific recommendations.


European Central Bank (2022), “Basic Economic Estimates”, 8 June.

European Commission (2021), “One year of COVID-19 outbreak: response to monetary policy”, 3 March.

European Commission (2022a), “2022 European Semester: Country Specific Recommendations / Commission Recommendations”, 23 May.

European Commission (2022b), “Commission Presents Fiscal Policy Guidelines for 2023”, 2 March.

European Fiscal Board (2021), “2021 Annual Report of the European Fiscal Board”, 10 November.

Thigesen et al. (2021), “Financial Support for Sustainable Recovery in the Eurozone”,, 16 June.

Verwey and others. (2022), “Russian invasion tests EU economic resilience”,, 20 May.

Leave a Reply

Your email address will not be published.