The economic impact of the pandemic has been enormous. Our latest Regional Economic Outlook for Europe forecasts a 7 percent decline in Europe’s GDP in 2020. The recovery from this crisis will be uneven and partial. While real GDP is projected to rebound by 4.7 percent in 2021, it would still be lower by 6.3 percent for 2021 relative to our pre-pandemic projections, implying a GDP loss of almost 3 trillion euros. Much of this loss will not be recouped over the medium term.
An unprecedented policy response, both in swiftness and scale, prevented a more devastating outcome. To give just one example: we estimate that at least 54 million jobs have at some stage been supported by job retention schemes in Europe. This has kept many families and firms afloat in these difficult times. EU-wide policies also made a difference. Risks remain significant and are rising as a second wave of infections is intensifying. Given the considerable uncertainty, policies must stay resolutely supportive to sustain the recovery.
The European response
A decisive policy response protected incomes and the productive capacity of the economy.
Fiscal policy did the heavy lifting. We estimate that the average size of announced discretionary fiscal measures for 2020 was 6.2 percent of GDP for Europe’s advanced economies and 3.1 percent of GDP for its emerging economies. This discretionary support came on top of Europe’s powerful automatic stabilizers. A large share of the fiscal packages was used for job retention programs and liquidity support for firms. These programs were highly successful in limiting the extent of job destruction and prevented a cascading of bankruptcies and bank closures.
Monetary policy and macroprudential policies were essential in providing favorable funding conditions for all sectors of the economy. Policy rate cuts, asset purchases, easing of conditions under which banks can obtain liquidity, and lowering of bank capital and liquidity buffers helped ensure the flow of credit, especially to small and medium-sized enterprises.
And highly accommodative monetary policies by the European Central Bank and other reserve currency economies had powerful international spillovers, easing monetary conditions including in emerging Europe. IMF emergency financing supported six European countries.
These policy interventions contributed to avoiding an even deeper recession and long-lasting economic scars on the European economy. For the EU economies, we estimate that without the policy actions and the strong EU support, economic activity might have been an additional 3-4 percentage points of GDP lower in 2020.
Lessons and challenges
Policymakers need to do whatever it takes to contain the pandemic and its economic damage, and not withdraw support prematurely to avoid repeating the mistake of the global financial crisis. Over time, support should become more targeted and also more flexible to facilitate the reallocation of resources and the transformation of the economy.
Protecting people’s health remains imperative, including through international cooperation.
Income support and job retention programs should remain in place. As the pandemic evolves and the economy starts to recover, the programs should be adapted from protecting jobs toward supporting workers, including through reskilling programs.
For companies, policies now need to go beyond liquidity support and ensure that insolvent but viable firms can remain in business. Our report finds that in advanced economies around one-third of the pandemic-induced solvency shortfall could be addressed by announced policies, such as wage subsidies, grants, or tax rebates. In emerging Europe, it is only around one-quarter. Thus, policies need to be put in place that facilitate speedy debt restructurings in or outside of bankruptcy, or in some cases make equity available to viable firms.
Long-term inflation that is generally anchored around or below targets and sizable economic slack suggest that central banks should keep highly accommodative monetary policies in place. Macroprudential easing should be unwound only gradually.
European banks entered the pandemic with strong capital and liquidity buffers and proved resilient to the unprecedented shock. Their resilience, together with the strong policy response, helped prevent a credit crunch. Our work suggests that absent new shocks, the average capital ratio of large EU banks should stay well above the minimum capital requirements. Still, nonperforming loans will rise and policymakers will need to facilitate their efficient disposal. And banks will need to engage with shareholders in developing a credible strategy to raise capital over the medium term.
Transforming the economy
This is also the time to design reforms that boost productivity growth and policies that help transform the economy, to reap the benefits of digitalization and mitigate climate change. Social systems can be improved and made more robust so that they can deal better with worker dislocation and retraining needs arising from automation and technological change. Policies, including better targeting of fiscal support, will also need to address the pernicious effects of the crisis and a likely sharp rise in inequality, especially as the youth, women, and least educated have been disproportionally affected.
Without the exceptionally strong and multifaceted policy response, the recession in Europe would have been far worse. Strong policy support needs to be maintained because the pandemic is intensifying and the recovery is still nascent and fragile. Once fiscal resources are freed from temporary support of people and firms, they should be redeployed to public investment that will build a more resilient, smarter, greener and more inclusive economy for tomorrow. For the EU countries, the Next Generation EU instrument can play an important role in this regard. And preparations should start on plans to rebuild policy space, which will need to begin once the recovery is in full swing. Together these actions will help limit the scarring from this crisis and thereby strengthen the capacity to deal with the public and private debt burden.
