The IMF warns in their latest Concluding Statement of the 2025 Mission on Common Policies for Member Countries that fragmented policies are costing Europe growth, stability, and global competitiveness.
Europe’s economy remains resilient, marked by low unemployment, inflation near target, and financial stability. However, it faces intensifying challenges, including trade tensions, defense and energy demands, low productivity, and aging demographics. The IMF argues that deeper integration of the EU single market is essential to overcoming these obstacles. This would enable more efficient investment and innovation through the joint provision of public goods, such as energy and defense, prevent duplicative national efforts, and internalize cross-border benefits. Fiscal strategies must balance sustainability with growing spending needs resulting from aging, the energy transition, and security concerns, while diversifying trade and maintaining monetary and financial stability are foundational to long-term resilience.
Outlook and Risks:
Amid a deteriorating global backdrop of protectionism and geopolitical risk, the euro area’s growth is projected at 0.8% in 2025 and 1.2% in 2026. Demand is dampened despite higher public spending, as consumer and business sentiment is affected by instability. Inflation hovers near 2%, with core inflation easing more slowly due to persistent services inflation and subdued wage growth. Downside risks to growth dominate, including trade tensions and geopolitical shocks. Inflation risks are more balanced, potentially driven lower by weak activity and a stronger euro, or higher due to supply disruptions, wage surprises, or larger fiscal outlays.
Structural Challenges:
Medium-term prospects are weighed down by long-standing constraints: slow productivity, aging, energy price volatility, and skill shortages. Deepening the EU single market is central to addressing these, particularly by eliminating internal barriers equivalent to high tariff equivalents. Key policy measures include:
- Reducing regulatory fragmentation (e.g., a voluntary EU-wide 28th corporate regime);
- Advancing the Capital Markets and Banking Unions to mobilize savings and credit;
- Improving labor mobility and recognition of qualifications;
- Integrating the energy market to stabilize costs.
These actions could lift EU potential GDP by 3% over 10 years. The digital euro could further unify cross-border payments and enhance financial integration.
Complementary national-level structural reforms are needed, particularly in labor markets, taxation, education, and business regulation. Closing 50% of the identified policy gaps could boost EU GDP by nearly 6% in the medium term. To mitigate external shocks, the EU trade strategy should focus on diversifying partnerships and limiting industrial policy to addressing specific market failures at the EU level.
Fiscal Policy:
Fiscal pressures are mounting due to debt burdens, aging populations, and increasing investment needs. For most euro area countries (excluding Germany), structural balances must shift from a -1.5% deficit in 2024 to a +1.4% surplus by 2030, a challenging task amid competing demands. Defense and energy needs alone could require 4.4% of GDP by 2050. Clear trade-offs must be communicated, and escape clauses for defense should be temporary. The EU’s fiscal rules must allow low-risk countries flexibility to invest in growth-enhancing and spillover-positive areas.
Coordinated EU-level investment—particularly in innovation, energy, and defense—can reduce costs and duplication. An estimated 50% increase in the EU budget will be needed to support these priorities while preserving existing programs. Improved performance-based budgeting, increased own resources, and borrowing capacity will ensure sustainable, efficient funding. EU-level investment could cut clean energy costs by 7%.
Monetary and Financial Sector Policies:
Given current inflation dynamics and a mildly negative output gap, a neutral policy rate of 2% is appropriate for now. Adjustments should follow developments in data and risk. The financial system is stable overall, but vulnerabilities in the growing non-bank financial institution (NBFI) sector, trade-related corporate exposures, and market volatility require attention. Authorities must prepare to provide emergency liquidity support to NBFIs and close data-sharing gaps that obstruct system-wide risk analysis.
Completing the Banking Union remains critical. Key steps include:
- Introducing a common deposit insurance;
- Allowing broader use of national deposit funds in resolutions;
- Enhancing central bank liquidity provision mechanisms;
- Implementing Basel III standards;
- Strengthening ESMA’s powers over leveraged funds and cross-border risks.
These measures will build a stronger, more integrated, and crisis-resilient financial system.
Conclusion:
Europe must pursue bold, coordinated, and multi-level reforms to address external shocks and internal weaknesses. Deepening the single market, implementing national reforms, modernizing fiscal frameworks, and completing financial integration are imperative. These actions will not only improve resilience and competitiveness but also unlock sustainable, long-term growth.