ECFIN's medium term projections: the risk of ësecular stagnation

Between spring and autumn 2014 the European Commission revised down its growth forecasts for 2014 and 2015. Other policy institutions have also lowered their projections for growth in the euro area and other regions, and the IMF warns that ësecularí (i.e. long-term) stagnation remains a risk. This paper presents DG ECFINís medium-term projections and analyses how structural unemployment, productivity trends and investment have contributed to persistence of slow growth since the ëgreat recessioní. The projections show that the decline in employment and productivity growth is not just a cyclical phenomenon. It is related to a slowdown in the growth rate of the working-age population, an increase in the non-accelerating wage rate of unemployment (NAWRU) and reduced trend total factor productivity (TFP) growth. However, the largest factor weighing on potential growth is low rates of capital formation. Apart from the slowdown in potential growth, deleveraging pressures are also exerting a negative effect on investment rates. Using the QUEST model, we cannot confirm that deleveraging will reduce growth permanently, as sometimes argued in the literature. An important reason for the protracted slowdown in euro area growth was the double-dip nature of the recession, which saw the financial crisis followed by the sovereign debt crisis. The second recession, in particular, highlighted the absence of supranational financial assistance mechanism in the euro area as well the need to address powerful fragmentation forces in financial markets. Since then, however, important steps have been taken, notably with the creation of the ESM and the establishment of a European banking union. The recently announced Investment Plan for Europe and a renewed commitment to structural reforms are also essential to counter risks of secular stagnation in the euro area.