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European Commission

MEMO

Brussels, 28 November 2012

Second Alert Mechanism Report on macroeconomic imbalances in EU Member States

What is the Macroeconomic Imbalance Procedure (MIP)?

Over the first decade of Economic and Monetary Union, a number of EU Member States witnessed a build-up of macroeconomic imbalances. These vulnerabilities proved to be highly damaging once the financial crisis set in. Against this background, the Macroeconomic Imbalance Procedure (MIP) was introduced in December 2011, as part of the so-called "six-pack" legislation, which reinforced the monitoring and surveillance of macroeconomic policies in the EU and the euro area. The aim of the MIP is to identify potential risks early on, prevent the emergence of harmful imbalances and correct the imbalances that are already in place. Surveillance of macroeconomic imbalances under the MIP forms part of the European Semester, which ensures integrated and forward-looking economic policy coordination in the EU.

The MIP has a preventive and a corrective arm. The preventive arm allows the Commission and the Council to adopt recommendations at an early stage before imbalances become excessive. The corrective arm triggers an Excessive Imbalance Procedure (EIP), which requires Member States to come forward with a corrective action plan. In order to ensure enforcement of the EIP, financial sanctions can be imposed on euro area Member States.

Which steps were taken during the first cycle of the Macroeconomic Imbalance Procedure?

Implementation of the MIP started on 14 February 2012 when the European Commission presented its first Alert Mechanism Report (AMR). On that occasion, 12 EU Member States were identified as warranting further economic analysis in order to determine whether macroeconomic imbalances existed or risked emerging (IP/12/132, MEMO/12/104). These countries were Belgium, Bulgaria, Cyprus, Denmark, Finland, France, Italy, Hungary, Slovenia, Spain, Sweden and the United Kingdom1. Subsequently, in-depth reviews were carried out on each of these Member States in order to examine the origin, nature and severity of possible macroeconomic imbalances. On 30 May 2012, the in-depth reviews were published.2 The analysis confirmed that these 12 Member States faced macroeconomic imbalances of different natures. The Commission considered that Spain and Cyprus were experiencing very serious imbalances, while the imbalances of France, Hungary, Italy and Slovenia were considered serious. None of these imbalances were deemed excessive (see below) in the sense of the procedure, but they all needed to be closely monitored (MEMO/12/388). Appropriate policy responses to these imbalances were integrated in the set of country-specific recommendations addressed to Member States under the European Semester, i.e. under the preventive arm of the MIP. These recommendations were endorsed by the European Council in June and subsequently adopted by the EU's Council of Ministers in July.

What is the Alert Mechanism Report?

The Alert Mechanism Report (AMR) is the starting point of the new cycle of the Macroeconomic Imbalance Procedure (MIP). Based on a scoreboard of indicators, it is a filter to identify countries and issues for which an in-depth review is deemed necessary. It should be noted that there is no automatic or mechanical interpretation of the results of the scoreboard indicators in the AMR, and the selection of countries for an in-depth review takes into account all available information. The conclusions of previous in-depth reviews are also taken into account. Economic judgement ensures that all pieces of information are put in perspective.

On this basis, the Commission identifies Member States that show signs of potential macroeconomic imbalances or face challenges in adjusting to imbalances, and should therefore be looked into further. In these in-depth reviews, the driving forces behind the observed developments are analysed in detail with a view to determine the nature of the imbalances, and to judge whether they are persistent, aggravating or unwinding. After this in-depth analysis, the Commission may conclude that no harmful imbalances exist or it proposes a recommendation under the preventive or the corrective arm of the MIP, if appropriate (see below).

Which countries are analysed in the Alert Mechanism Report?

The Alert Mechanism Report (AMR) looks at all EU Member States except those that are subject to enhanced surveillance under economic adjustment programmes supported by official financing. This concerns Ireland, Greece, Portugal and Romania. The aim of this approach is to avoid duplication of procedure and reporting obligations.3

On which economic indicators is the scoreboard used in the Alert Mechanism Report based?

The scoreboard is made up of eleven indicators with a view to monitor external imbalances and competitiveness as well as internal imbalances (please see the individual indicators below). The indicators in the scoreboard allow an early identification of imbalances that emerge over the short term as well as of imbalances that arise due to structural and long-term trends. Indicative thresholds have been set for each indicator.

Compared to the scoreboard in the Alert Mechanism Report (AMR) of February 2012, which consisted of ten indicators, an additional indicator on the growth rate of financial sector liabilities has now been added. This eleventh indicator is intended to better capture the linkages between the real economy and the financial sector. The definitions of the other ten indicators have remained unchanged.

The design of the scoreboard is currently as follows:

External imbalances and competitiveness

  1. 3 year average of the current account balance as a percentage of GDP, with an indicative threshold of +6% and - 4% of GDP;

  2. net international investment position (NIIP) as a percentage of GDP, with an indicative threshold of -35%; the NIIP shows the difference between a country's external financial assets and its external financial liabilities;

  3. 5 years percentage change of export market shares measured in values, with an indicative threshold of -6%;

  4. 3 years percentage change in nominal unit labour cost (ULC), with indicative thresholds of +9% for euro area countries and +12% for non-euro area countries.

  5. 3 years percentage change in real effective exchange rates (REER) based on HICP deflators, relative to 35 other industrial countries, with indicative thresholds of -/+5% for euro area countries and -/+11% for non-euro area countries; the REER shows price competitiveness relative to the main trading partners.

Internal imbalances

  1. private sector debt as a percentage of GDP with a threshold of 160%;

  2. private sector credit flow as a percentage of GDP with an indicative threshold of 15%;

  3. year-on-year percentage change in deflated house prices, with an indicative threshold of 6%;

  4. public sector debt as a percentage of GDP with an indicative threshold of 60%;

  5. 3-year average of unemployment rate, with an indicative threshold of 10%;

  6. year-on-year percentage change in total financial liabilities of the financial sector, with an indicative threshold of 16.5%.

What are the findings on overall macroeconomic developments in the EU?

There are positive signs that the adjustment of macroeconomic imbalances is progressing, as evidenced by the Commission's latest economic forecast (IP/12/1178). The reforms undertaken in many EU Member States appear to be bearing fruit. For example, saving rates in the private and public sectors and the economies as a whole have increased. Moreover, current account deficits are coming down in the countries with the largest external imbalances. This is supported by gains in competitiveness and by recent unit labour cost developments in several countries concerned, which point to more rebalancing down the road. However, it has to be noted that a compression of domestic demand and imports has also contributed to the reduction of current account deficits. Besides the adjustment in Member States with large current account deficits, the current account balances of several Member States in surplus have also been declining, albeit at a slower pace.

Although adjustment is taking place in many areas, there is still a long way to go before a complete and durable rebalancing is achieved. The adjustment of accumulated macroeconomic imbalances is however crucial to boosting economic growth and job creation in the medium and long term.

Which countries are identified as warranting an in-depth review in the new Alert Mechanism Report?

Based on the economic analysis and the scoreboard with 2011 data, the Commission considers that 14 Member States warrant an in-depth review. These include the 12 Member States that were considered to face imbalances in May 2012 (MEMO/12/388). In addition, the Commission finds that Malta and the Netherlands warrant an in-depth review. It is worth stressing that the Commission has not identified an imbalance at this stage, but is simply identifying the countries that deserve a more detailed analysis before reaching a conclusion.

Why does the Commission suggest taking a closer look at developments in Malta and the Netherlands?

On the basis of the updated scoreboard, and considering economic developments (for example the Commission's autumn forecast), the Commission considers that it would be useful to take a closer look at macroeconomic developments in Malta and the Netherlands to further examine potential risks.

Malta: Malta's financial sector requires closer investigation. Potential risks relate to the nexus of an extremely large financial system and the high exposure of the banks to the property markets, in combination with high private sector indebtedness. Moreover, the size of the financial system is very large.

The Netherlands: There is a need to investigate more in-depth the potential risks stemming from a very elevated level of private sector debt in combination with high house prices.

What will be the next steps following the Alert Mechanism Report?

The conclusions of the Alert Mechanism Report (AMR) will be discussed in the Eurogroup – if they concern euro area Member States – and in the ECOFIN Council. This enables the Commission to obtain appropriate feedback from Member States. The Commission is also looking forward to the contribution of the European Parliament and key stakeholders. Taking all the reactions into account, the Commission will prepare country-specific in-depth reviews in the coming months and present them in spring. This will involve a dialogue with the Member States concerned.

What is the possible outcome of an in-depth review?

An in-depth review does not automatically lead to a recommendation. The Commission's analysis could result in one of three different scenarios shown by the graph below.

Overview of the Macroeconomic Imbalance Procedure:

1. If the situation is considered unproblematic, the European Commission will conclude that no further steps are necessary under the Macroeconomic Imbalance Procedure (MIP).

2. If the European Commission considers that a macroeconomic imbalance exists or could arise, it will come forward with the appropriate recommendations under the preventive arm of the MIP. The Member State concerned will be asked to correct the imbalance or prevent an imbalance from occurring. These recommendations would be presented in the context of the European Semester as part of the package of country-specific recommendations (May).

3. If the macroeconomic imbalances are considered severe or excessive and may jeopardise the proper functioning of the Economic and Monetary Union, the European Commission can recommend that the Council of Ministers places the Member State under an Excessive Imbalance Procedure (EIP), this is the corrective arm of the Macroeconomic Imbalance Procedure. In this case, the Member State concerned will have to submit a 'corrective action plan' with a clear roadmap and deadlines for implementing adequate measures. Surveillance will be stepped up by the Commission on the basis of regular progress reports drawn up by the Member State concerned.

Are any sanctions planned to ensure that the Macroeconomic Imbalance Procedure is properly carried out?

There are no fines foreseen under the preventive arm of the Macroeconomic Imbalance Procedure. However, if the Member State concerned does not take sufficient action to address imbalances identified in the scope of the in-depth reviews, it risks a further build-up of imbalances and the possibility of an Excessive Imbalance Procedure.

Under the Excessive Imbalance Procedure, financial sanctions (up to 0.1% of GDP) are foreseen for euro area Member States if the country concerned fails to comply with the recommended corrective action. It should be stressed that it is the failure to take agreed action that could be sanctioned, not the fact that the imbalance has not disappeared. A sanction can also be imposed for twice failing to submit a sufficient corrective action plan.

What is the legal basis of the Macroeconomic Imbalance Procedure?

The Macroeconomic Imbalance Procedure (MIP) is based on two Regulations. The first (Regulation 1176/2011) sets out the details of the new surveillance procedure and covers all 27 EU Member States. The second (Regulation 1174/2011) focuses on enforcement, including the possibility of sanctions, and only applies to euro area Member States.

For further information:

http://ec.europa.eu/economy_finance/economic_governance/macroeconomic_imbalance_procedure/index_en.htm

AMR:

http://ec.europa.eu/economy_finance/economic_governance/documents/alert_mechanism_report_2012-11_en.pdf

IP/12/1275

MEMO/12/388

MEMO/12/104

IP/12/132

1 :

Please note that the programme countries (Ireland, Greece, Portugal and Romania) are not assessed in the Alert Mechanism Report, as they are already under enhanced economic surveillance.

2 :

The in-depth reviews of May 2012 are available at European Economy-Occasional Papers, 99 to 110, please see http://ec.europa.eu/economy_finance/publications/occasional_paper/2012/index_en.htm.

3 :

Spain is discussed in the report, although it benefits from official financing for the recapitalisation of banks. Cyprus and Hungary are also discussed as negotiations for financial assistance have not yet been concluded. Once either of them becomes a programme country, the Macroeconomic Imbalance Procedure will be suspended and replaced by the programme monitoring reviews.


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