EUROFRAME-EFN Autumn Report: Euro Area is doing well

Unemployment will continue to decline and the inflation rate is projected to slow down to 2 per cent in 2008, assuming oil prices will remain high in the coming years.

This is the main message of a report published today by EUROFRAME-EFN, a network of ten economic research institutes in Europe in which CPB participates. The projections are broadly in line with the CPB forecasts published earlier this month in the Macro Economic Outlook (Macro Economische Verkenning).

The report also assesses macro-economic policy of euro area countries. It is expected that the ECB will raise its interest rate to 3.5 per cent by the end of the year, because of rising inflationary expectations, increasing liquidity and the favourable growth outlook. Rates will then probably be left at that level in 2007. Government finances are improving almost everywhere. Italy and Portugal are the only countries with deficits exceeding the Maastricht-norm of 3% of GDP.

The high US current account deficit is a major risk to the forecast. The current account impact of shocks to US house prices and US housing investment and to the US dollar are estimated. Substantial shocks are required to bring the current account deficit down, with severe negative growth effects in the US, but remarkably limited impacts on the euro area, mainly through declining real interest rates.

The special topic of the report deals with convergence in the euro area. Growth and inflation differentials have declined, but not disappeared. Growth differentials are largely explained by supply factors, whereas persistent inflation differentials primarily relate to diverging wage trends. Inflation differentials may contribute to high real interest rates in low inflation countries and visa versa. So far there have been no major asymmetric shocks affecting individual economies within the euro area so that the potential effects of the loss of policy options of individual member states have not yet been fully tested.

The Autumn Report 'Economic Assessment of the Euro Area: Forecasts and Policy Analysis' is available on the website of EUROFRAME.

EUROFRAME European Forecasting Network (EFN) is a research network in which CPB cooperates. At the European Commission's request, it produces bi-annual reports on the euro area. Other members of the network are: DIW (Berlin), ESRI (Dublin), ETLA (Helsinki), IfW (Kiel), NIESR (London), OFCE (Paris), PROMETEIA (Bologna), WIFO (Vienna) en CASE (Warsaw).