An evolving euro area policy mix

In the first 25 years of the euro, the common currency proved itself to be resilient to a variety of large economic shocks. These shocks have led to changes in the functioning of the euro area and a broader reconsideration of how to make the responses of national fiscal policies and ECB monetary policy more effective. In the wake of the 9/11 terrorist attack in 2001, the euro area economy recovered rather quickly thanks to a supportive policy mix. The global financial crisis (GFC) that hit the euro area in 2008-09 was followed by the euro sovereign debt crisis, which tested the functioning of the euro area and gave rise to significant policy responses. Despite the demonstration of institutional solidarity, the euro area’s institutional shortcomings and a lack of sufficient fiscal buffers in some highly indebted Member States, due to an inappropriate fiscal policy stance in the years before the GFC, were not conducive to an appropriate policy mix: fiscal policy at this time was pro-cyclically restrictive even in countries with fiscal space, and monetary policy support was delayed. The lessons learnt from that crisis, and a broader rethink in academic and policy circles about the benefits of activist fiscal policies in the case of large economic shocks, led to a highly successful response to the COVID-19 crisis, with EU institutions stepping up promptly and introducing innovative common tools, complementing an overall supportive fiscal-monetary policy mix in the euro area. The policy response to the energy crisis and inflation surge in 2022 was also broadly effective, with the ECB rapidly increasing policy interest rates to keep inflation expectations anchored, while governments put fiscal support measures in place to protect households and firms from the impact of higher energy prices. The challenge for the future is now to reduce the high levels of public debt accumulated in some euro area countries, while making decisive progress on the green and digital transitions. The new EU fiscal framework will help enhance the macroeconomic stabilisation role of fiscal policy, while focusing on debt sustainability and growth-enhancing policies.