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European Commission

MEMO

Brussels, 13 November 2013

Third Alert Mechanism Report on macroeconomic imbalances in EU Member States

What is the Alert Mechanism Report (AMR)?

The Alert Mechanism Report (AMR) is the starting point of the yearly cycle of the Macroeconomic Imbalance Procedure (MIP), which aims at identifying and addressing imbalances that hinder the smooth functioning of the EU economies and may jeopardise the proper functioning of the Economic and Monetary Union. The AMR identifies the Member States for which further analysis (in the form of an in-depth review) is deemed necessary in order to decide whether an imbalance in need of policy action exists. In this regard, the AMR is an initial screening device, based on a scoreboard of indicators with indicative thresholds, plus a set of auxiliary indicators. It should be stressed that the AMR is not a mechanical exercise. It is not because a Member State reports an indicator beyond the indicative thresholds that an in-depth review is launched, as the Commission takes the complete economic picture into account.

It is only on the basis of the in-depth reviews that the Commission will conclude whether imbalances, and potentially excessive imbalances, exist and put forward the appropriate policy recommendations. The in-depth reviews will be published in spring 2014 and will feed into the analysis underpinning next year’s country-specific recommendations under the 'European Semester' of economic policy coordination.

Which countries are analysed in the AMR?

The AMR is the first stage in the yearly cycle of the MIP. The AMR looks at all EU Member States except those that are benefiting from official financial assistance, since the surveillance of these countries’ imbalances and the monitoring of corrective measures will continue in the context of their economic adjustment programmes. This concerns Greece, Cyprus, Portugal and Romania1. Ireland's situation will be assessed at the end of its financial assistance programme, which will happen shortly. Such an assessment will also happen for the other four countries once they are no longer under a programme.

On which economic indicators is the scoreboard used in the AMR based?

The scoreboard used in the AMR is currently made up of eleven indicators with a view to monitor external imbalances and competitiveness as well as internal imbalances. 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.

The current AMR includes for the first time a set of auxiliary social indicators which are useful for the interpretation of the scoreboard of indicators. This includes for example the rate of people at risk of poverty or social exclusion and the share of persons (as percentage of the total population) who are living in households with very low work intensity. However, there are no thresholds for these auxiliary indicators.

The design of the scoreboard is currently as follows:

External imbalances and competitiveness

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

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;

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

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.

3 years percentage change in real effective exchange rates (REER) based on HICP deflators, relative to 41 other industrial countries2; 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

private sector debt (consolidated) as a percentage of GDP, with a threshold of 133%3;

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

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

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

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

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

What is an imbalance?

Regulation No 1176/2011 on the prevention and correction of macroeconomic imbalances defines a macroeconomic imbalance as 'any trend giving rise to macroeconomic developments which are adversely affecting, or have the potential adversely to affect, the proper functioning of the economy of a Member State or of the Economic and Monetary Union, or of the Union as a whole', while excessive imbalances are 'severe imbalances that jeopardise or risk jeopardising the proper functioning of the Economic and Monetary Union'.

In general, any deviation from a desirable level can be considered as an imbalance. However, not all imbalances are detrimental or require policy interventions as they may be part of the economy's dynamic adjustment. Imbalances that require close monitoring and possibly policy interventions relate to developments that could significantly impede the proper functioning of the economy of a Member State, the euro area or the EU. In practice, these are imbalances that are either at dangerous levels (e.g. high debts) or reflect unsustainable dynamics (e.g. excessive house price or credit increases) that threaten to result in abrupt and large, and hence damaging, adjustment. For example, having a large and persistent current account deficit is considered an imbalance if it runs the risk of leading to a 'sudden stop' and ensuing large welfare costs.

What are the findings of this AMR on overall developments in the EU?

The EU economies continue to progress in correcting their external and internal imbalances. These imbalances, notably abundant credit, large and persistent current account deficits and surpluses, loss of competitiveness and accumulation of debt contributed to the crisis. Over the most recent years, there has been progress in several areas. In particular a reduction in deficits, and significant cost competitiveness improvements have been recorded in a number of Member States, stimulated by structural reforms and market pressure. Generally, the correction of imbalances is contributing to a gradual recovery. At the same time, the progressive normalisation in economic conditions is helping to reduce the imbalance-related macroeconomic risks. The growth outlook is now better than a year ago, and progress in re-balancing will open up the way for growth and convergence4.

However, the imbalances that aggravated the crisis have reduced but not vanished. There has been little progress in reducing excessive debt, although credit growth has been very low or even negative in many countries; improvement in the net international investment position of the most indebted economies has been slow.

Which countries are identified as warranting an in-depth review in the current AMR?

The current AMR shows that it is necessary to analyse in further detail the accumulation and unwinding of imbalances, and the related risks, in 16 EU Member States. For some countries the in-depth reviews will elaborate on the findings of the previous cycle5 of the MIP, while for others, it will be the first time that the Commission will prepare an in-depth review. The several Member States for which the Commission intends to prepare an in-depth review have different challenges and potential risks including spillovers on their partners.

Spain and Slovenia were found to be experiencing excessive imbalances in the previous round of the MIP. Therefore, the upcoming in-depth review will assess the persistence or unwinding of the excessive imbalances, and the contribution of the policies implemented by these Member States to overcome these imbalances.

France, Italy and Hungary were found to be experiencing imbalances in the previous round of the MIP and the Commission indicated the necessity of adopting decisive policy actions. The upcoming in-depth review will assess the persistence of imbalances.

For the other Member States previously identified as experiencing imbalances (Belgium, Bulgaria, Denmark, Malta, the Netherlands, Finland, Sweden and the United Kingdom), the in-depth review will help to assess the extent to which imbalances persist or have been overcome. In the logic of the MIP, in the same manner as imbalances are identified after the detailed analyses in the in-depth reviews, the conclusion that an imbalance has been overcome should also take place after duly considering all relevant factors in another in-depth review.

In-depth reviews will also be prepared for Germany and Luxembourg in order to better scrutinise their external position and analyse internal developments, and conclude whether either of these countries is experiencing imbalances.

Finally, an in-depth review is also warranted for Croatia, a new member of the EU, given the need to understand the nature and potential risks related to the external position, trade performance and competitiveness, as well as internal developments.

In the case of some countries like Germany the report refers inter alia to the high current account surplus. Isn't a current account surplus a good thing?

Current account deficits and surpluses are not necessarily imbalances in the sense of developments which are adversely affecting – or have the potential to affect – the proper functioning of economies of the Economic and Monetary Union, or on a wider scale. Deficits and surpluses are a natural consequence of economic interactions between countries. External borrowing and lending allows countries to transfer consumption over time. A country with a current account surplus transfers consumption from today to tomorrow by investing abroad. In turn, a country with a current account deficit can increase its consumption today but must transfer future income abroad to redeem the external debt, by consuming less than it produces. The current account surplus or deficit corresponds to exports minus imports plus the net income flow (like interest and dividends paid to and received from abroad) and net current transfers (like migrants' remittances). The current account can also be calculated as the difference between domestic savings and domestic investment.

Therefore a surplus in the current account means that the country is generating more savings than it is investing domestically or, equivalently, that domestic income exceeds domestic consumption and domestic investment. This implies that the country is investing abroad, exporting capital and, as a result, accumulating foreign assets (i.e. credits, foreign direct investment, etc.) vis-à-vis the rest of the world.

However, surpluses can also be the result of incorrect expectations, mispricing of risks, or market distortions, or they may reflect misguided policy interventions or weaknesses in financial supervision. These market or policy failures imply a misallocation of resources and a build-up of imbalances and vulnerabilities in both surplus and deficit countries. The misallocation of resources will entail welfare losses also in the surplus countries. In these cases, it would be in the interest of these countries to reduce their surpluses, by removing the obstacles hampering their domestic demand. The Commission published a special report on current account surpluses in December 2012 (http://ec.europa.eu/economy_finance/publications/european_economy/2012/pdf/ee-2012-9_en.pdf).

So are current account surpluses as problematic as current account deficits?

In general the risks are higher for current account deficits than for current account surpluses, because the former raise concerns about the sustainability of the external debt of a country. But this does not mean that surpluses cannot be the result of inefficiencies or constitute an imbalance, especially when they are large. Surveillance under the MIP covers both current account deficits and current account surpluses. The asymmetry in the scoreboard reflects the fact that the risks related to deficits are higher, as the threshold is 4% of GDP for current account deficits and 6% of GDP for surpluses.

What is the level of the German current account surplus?

In the case of Germany the scoreboard indicator defined as the three-year average of the current account balance is 6.5% and therefore above the indicative threshold of 6%. Following statistical revisions, the indicator has exceeded the 6% threshold of the scoreboard in the AMR each year since 2007. Latest data, together with the Commission’s Autumn Forecast, suggest an annual surplus in 2013 at the same level as in 2012: 7% of GDP. Looking ahead, the surplus is expected to remain above 6% over the forecast horizon until 2015, thus suggesting that it is not a short-lived cyclical phenomenon. The German current account surplus is one of the largest in the world in absolute terms and a main factor behind the current account surplus of the euro area as a whole (the other being that the deficit countries had to reduce their excess consumption due to market pressure).

So what is the Commission recommending to Germany? Decreasing its exports?

No, this is a false assumption. This exercise by no means aims at restraining Germany's competitiveness or export performance. The benefits of German competitiveness and its relevance for growth for both Germany and the rest of Europe are undisputed. In general it should be noted that the AMR is not about making recommendations. As mentioned above, its aim is to identify countries that warrant an in-depth review.

A closer analysis is deemed appropriate in order to investigate the nature of the German current account balance, the specific factors behind its level and persistence, and the role that domestic policies can play in promoting domestic demand. It is only on the basis of the in-depth review that the Commission will conclude whether imbalances exist and put forward the appropriate policy recommendations.

However, it is obvious that the large surplus reflects higher savings than investment in the German economy. The household saving rate is among the highest in the euro area. Despite the second-lowest share of private sector debt to GDP in the euro area and favourable interest rate conditions for credits, the private sector has continued to decrease its indebtedness albeit at a reduced pace thus failing to support a more buoyant private sector demand.

An increase in investment and/or reduction in their overall savings could be beneficial for Germany and other surplus countries like the Netherlands, without impairing their competitiveness, all the more so as surplus countries tend to have investment-to-GDP ratios lower than the EU average.

In the context of the 2013 European Semester, the Council of Ministers recommended to Germany to sustain conditions that enable wage growth to support domestic demand, for example by reducing high taxes and social security contributions, especially for low-wage earners. Moreover, it was recommended that Germany takes measures to further stimulate competition in the services sectors including construction, and – among other measures in the field of energy policy – to continue efforts to accelerate the expansion of the energy networks. For further information please see: http://register.consilium.europa.eu/pdf/en/13/st10/st10636-re01.en13.pdf.

What are the next steps following the AMR?

The conclusions of the AMR will be discussed in the Eurogroup – if they concern euro area Member States – and in the Economic and Financial Affairs Council (ECOFIN) in December. The Commission is also looking forward to the contribution of the European Parliament and key stakeholders. Moreover, the European Council will hold a discussion in December following the publication of the Annual Growth Survey and the AMR with the aim of agreeing on the main areas for coordination of economic policies and reforms.

Taking all the reactions into account, the Commission will prepare country-specific in-depth reviews in the coming months and present them in the 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 or the identification of imbalances. The Commission's analysis could result in one of three different scenarios shown by the graph below.

Is the Commission expecting the next round of in-depth reviews to conclude that some countries no longer have imbalances?

In this cycle all the 13 countries for which imbalances were identified in the previous cycle have again been selected for an in-depth review. The persistence or disappearance of imbalances will thus be decided after the in-depth reviews in spring. For some countries this will be the third generation of in-depth reviews and risks have been thoroughly assessed and better understood, while in some cases economic conditions have improved and risks are being gradually reduced. Therefore it is possible that for some of these countries imbalances will not be identified again.

Overview of the Macroeconomic Imbalance Procedure:

1. If the situation is considered unproblematic, the Commission will conclude that no further steps are necessary under the MIP.

2. If the 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 are presented in the context of the European Semester as part of the package of country-specific recommendations (May/June).

3. If the macroeconomic imbalances are considered severe or excessive and may jeopardise the proper functioning of the Economic and Monetary Union, the Commission can recommend that the ECOFIN Council places the Member State under an Excessive Imbalance Procedure; this is the corrective arm of the MIP.

Are any sanctions planned to ensure that the MIP is properly carried out?

There are no fines foreseen under the preventive arm of the MIP.

As regards the corrective arm, i.e. if an Excessive Imbalance Procedure is launched, the situation is different: In this case financial sanctions (up to 0.1% of GDP) are foreseen for euro area Member States if they repeatedly fail to deliver a sufficient corrective action plan or to take agreed action. It is important to note that it is the failure to take adequate measures that could be sanctioned, not the fact that the imbalance has not disappeared.

What is the link between the Alert Mechanism Report and the Annual Growth Survey which was also presented today?

The implementation of the MIP is embedded in the 'European Semester', with the aim of ensuring consistency with other economic surveillance tools. The Annual Growth Survey, which appears at the same time as the AMR, elaborates on the interlinkages between the correction of macroeconomic imbalances under the MIP, and the urgent challenges of promoting growth, fighting unemployment, ensuring sustainable fiscal policies and restoring lending.

Please find the full Alert Mechanism Report here:

http://ec.europa.eu/europe2020/pdf/2014/amr2014_en.pdf

For further information:

IP/13/1064 European Semester 2014: EU economy enters recovery phase

IP/13/313 (In-depth reviews)

MEMO/13/322 (In-depth reviews)

MEMO/13/458 (Country-specific recommendations)

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

1 :

Spain is discussed in the report, although it benefits from official financing for the recapitalisation of banks.

2 :

Compared to last year, there is a shift from 35 to 41 partners to consider Croatia, China, Russia, Brazil, South Korea and Hong Kong.

3 :

Compared to last year, given progress in statistics, there is a shift from non-consolidated debt to consolidated debt, and the indicative threshold was appropriately adjusted.

4 :

See also the Autumn Economic Forecast of the European Commission published on 5 November 2013: http://ec.europa.eu/economy_finance/eu/forecasts/2013_autumn_forecast_en.htm

5 :

In April 2013, the Commission identified imbalances in Belgium, Bulgaria, Denmark, Spain, France, Italy, Hungary, Malta, the Netherlands, Slovenia, Finland, Sweden and the United Kingdom, among which Spain and Slovenia were experiencing excessive imbalances (cf. 'Results of the in-depth reviews,' COM (2013) 199 final, 10.4.2013, and 'Macroeconomic Imbalances,' European Economy-Occasional Papers, 132-144). For the full set of country-specific recommendations adopted by the Council, including those which are relevant to overcome imbalances, see OJ C217, 30.7.2013, p.1.


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