According to International Monetary Fund (IMF), Europe must address a toxic mix of high inflation and flagging growth. As the head of the IMF's European Department, Alfred Kammer told the audience at Goethe University at the presentation of the new Regional Economic Outlook, this winter more than half of the countries in the euro area will experience a technical recession as Russia’s war in Ukraine takes a rising toll on Europe’s economies.
According to the IMF, higher energy prices have increased European households‘ cost of living by some 7 percent on average in 2022 despite widespread measures taken to ease this burden.
During the joint event IMF IMFS event, Kammer presented the new forecast predicting Europe’s advanced economies will grow by just 0.6 percent in 2023. The IMF expects inflation to stay significantly above central bank objectives, at about 6 percent in advanced economies. Kammer illustrated that, according to latest outlook, the pandemic and Russia’s war in Ukraine might have fundamentally altered the inflation process, with rising input and labor shortages contributing notably to the recent high-inflation episode. Kammer warned that Eurpopean policymakers face severe trade-offs and tough policy choices as they address a toxic mix of weak growth and high inflation that could worsen. Even though the energy crisis in Europe, triggered by the cessation of Russian natural gas supplies, is challenging the continent this winter, next winter is likely to be even more difficult, the IMF said.
In its outlook, the IMF recommended policymakers to tighten macroeconomic policies to bring down inflation, while helping vulnerable households and viable firms cope with the energy crisis. Due to the high uncertainty, they should also stand ready to adjust policies in either direction, based on whether incoming data signals higher inflation, a deeper recession or both. According to the IMF outlook, central banks should continue raising policy rates for now. The IMF emphasizes that this is also an insurance policy against risks, including a de-anchoring of inflation expectations or a feedback loop between prices and wages, which would then require even stronger and more painful central bank responses.
Regarding fiscal policy, the IMF recommended to support low- and middle-income households through lump-sum rebates on their energy bills instead of price interventions. As an alternative, the IMF pointed out to combine general lump-sum discounts with additional support for the poor through the welfare system, financed by higher taxes for high-income households. A less efficient alternative, in the IMF’s view, is to implement higher tariffs for higher levels of energy consumption, which is considered not fully targeted but still a better option than broad prices caps.
IMF Regional Economic Outlook for Europe
IMF-IMFS Event to Launch the IMF Regional Economic Outlook for Europe (Video)