Speech

Rising to the Challenge: Europe’s Path to Growth and Resilience

May 19, 2025

Good afternoon,

Thank you, Karel, for the introduction and CEPS for hosting this event. I would also like to extend a warm thank you to Cinzia and Maarten for taking time out of your busy schedules, and to all of you for joining us today.

Europe has achieved much over the last 75 years.

The “economic miracle” of the post-WWII period brought the rapid recovery in income levels. The “Great Moderation” (1980s-2000) following the oil crises in the 1970s offered stable growth at declining inflation rates. And advances in regional integration—for example through the Single European Act in 1986–and global trade helped lift productivity and income levels in Europe. The result was income per capita in advanced European countries growing by two and a half times between 1960 and the end of the century, on par with the US.

Europe has shown grit when it mattered. Resolute policymaking helped overcome the double blow of the Global Financial Crisis and the European debt crisis. And Europe stepped up again during the Covid-19 pandemic and the energy crisis following Russia’s invasion of Ukraine.

But more work needs to be done.

The world is changing fast. Today, we are confronted with a more shock-prone, uncertain, and fragmented world. This adds to a series of domestic challenges in Europe. Some are longstanding: The great European project remains unfinished, the population is aging, climate change requires attention, and there is a worrying productivity gap with the most dynamic economies. Other challenges have become prominent only more recently, such as the need to bolster national and energy security. And, in many countries, there is limited fiscal space to meet these growing challenges.

Europe must once again step up if it wants to preserve its prosperity. Kicking the can down the road will soon make it impossible to fulfill commitments to social welfare, climate action, and national defense. Delivering on these fronts is existential—Europe’s economic and social model is at stake.

The deteriorating external environment weighs on Europe’s economic outlook.

In our latest World Economic Outlook, we project global growth to reach only 2.8 percent this year, in part due to ongoing trade and policy uncertainty. In the United States, growth is expected to slow to 1.8 percent from heightened tariffs, economic uncertainty, and softer demand, while China's growth forecast is lowered to 4 percent. These numbers do not reflect the latest developments, which could mean lower tariffs than assumed in April. But uncertainty remains extraordinarily high and holds back consumption and investment.

And trade and policy uncertainty also led us to downgrade growth in Europe despite some offsetting factors: Germany plans to ramp-up infrastructure spending and European defense spending is projected to increase significantly.

• For the euro area, we expect growth at 0.8 and 1.2 percent in 2025 and 2026, a reduction of 0.2 percentage points in both years since our January projection. Growth in the more trade-exposed CESEE region slows by even more, reaching 2.4 in 2025 and 2.7 in 2026, a downgrade of 0.6 and 0.4 percentage points, respectively.
• High frequency indicators and euro area GDP flash estimates (excluding volatile figures for Ireland) in the first quarter of the year are consistent with our projections.

Inflation is decelerating and approaching targets, driven by lower energy prices and tepid demand.

There are notable risks around the baseline.

First, an escalation of trade tensions would further weaken external demand and increase uncertainty.

Second, a reconfiguration of supply chains could impact activity and inflation. In our view, trade diversion to Europe from countries more affected by US tariffs is a small risk on aggregate. But it could lead to losses in export shares for specific sectors in some countries, especially those CESEE countries with persistent real wage growth.

A third risk is a delay in the necessary fiscal consolidation, which could reignite concerns about repayment capacity.

So, how can Europe rise to these challenges and secure its prosperity?

Europe needs an ambitious and concerted push to advance long-stalled reforms to boost growth and economic resilience.

Action should be carried out both at the EU level to deepen the single market, and domestically to make product and labor markets more growth friendly.

The forthcoming EU budget for 2028-2034 should support and incentivize the reform push and meet the growing need for European public goods.

This reform effort must be anchored in a steady macro-policy response and open trade policies.

Let me look at some of the details.

Starting with macroeconomic policy…

…central banks should continue to normalize monetary policy while remaining focused on durably reaching price stability targets. The ECB should lower its policy rate to 2 percent this summer and maintain it there, barring major shocks. In CESEE countries, where inflation is still higher and more persistent, central banks should ease cautiously.

Fiscal policymakers will have to find ways to accommodate rising spending needs in a sustainable way. In countries where public debt is already high, consolidation is warranted, and reprioritization is necessary to accommodate new spending needs.

Regarding trade policy, Europe—and indeed everyone—needs more trade.

The global trade regime has shifted, and some reallocation of resources and reconfiguration of value chains appear inevitable. At the same time, it is important to not over-react.

For example, while US-China tariffs may divert some trade to Europe, we estimate that even with April’s high tariff rates the aggregate effects would be small—to the order of 0.25 percent of EU GDP or about 3 percent of extra-EU imports. Although the effects could be more pronounced in certain industries, it is far from clear whether safeguard measures are required. Where measures are deployed, they must align with WTO principles, be time-limited, and clearly communicated.

Europe should avoid tariff escalation; and it should protect people, not stand in the way of structural change.

Let me now turn to the structural policies Europe needs to boost growth and resilience.

I will focus on EU and domestic reforms with the highest urgency and potential. I will emphasize their complementarity and the need to pursue comprehensive reform packages to enhance political support.

I will also highlight the key role that the next EU budget can play in supporting the reform effort, and ultimately secure Europe’s prosperity.

First, it is high time to reboot the EU single market.

Europe has come a long way, but the EU single market remains far from complete. For instance, it can take up to 6 months for an EU worker who relocates to another EU country to be legally employed there. Large differences across bankruptcy procedures discourage cross-border investment, while having national stock markets introduces vast inefficiencies in the allocation of capital across the continent. This fragmentation increases costs and hurts business dynamism and growth.

Full integration of the single market would yield tremendous benefits. Our modeling work shows that a 10 percent reduction in barriers to intra-EU goods trade and multinational production would lift GDP by around 7 percent [4]. But we need to take concrete steps in this direction. In a forthcoming paper [5], we list four priority areas:

1. Adopting high-quality insolvency rules within a 28^th regime for firms to simplify the regulatory landscape
2. Advancing the capital markets union to boost venture capital and equity investment
3. Increasing labor mobility across the EU, and
4. Better integrating the European electricity market

Presenting these reforms as a package may increase the buy-in from member states that see benefits in some areas more than others, while remaining realistic on feasibility.

We find that just this package of selected actionable measures could raise EU GDP by approximately 3 percent over the next 10 years—a significant downpayment on the full potential gains from completing the single market.

Second, advancing EU and domestic policy actions together would magnify the growth impact of reforms.

In another paper to be published in a few days [6], we also highlight the significant potential gains from domestic reforms.  A package of reform priorities addressing policy gaps in labor markets, business regulation, and credit and capital markets could boost output by approximately 5 percent in advanced European economies and up to 7 percent in CESEE countries over the medium term.

A coordinated reform effort at both domestic and EU levels would likely yield benefits that exceed the cumulative returns from isolated actions in the two areas. For example, advancing the capital markets union would boost the effect of domestic initiatives to support innovative startups. And improving skill levels at the national level will amplify EU R&D efforts.

Across all areas, think smart and big. Structuring reforms as “packages” in which everyone can see direct benefits can enhance domestic political support and facilitate successful implementation.

Third, the EU budget has the potential to be a powerful lever for advancing policy priorities across both the European Union and its member states.

The EU’s Multiannual Financial Framework (MFF) has helped tackle shared challenges—promoting economic convergence through cohesion policy and strengthening resilience via NextGenerationEU. To meet existing and emerging challenges, we suggest that the 2028–2034 MFF be revamped along three key lines [7].

1. Prioritize European public goods. The EU budget should allocate more resources to key areas of shared strategic interest—such as R&D, the clean energy transition, energy security, and defense. These are domains where collective investment delivers greater efficiency and cost savings compared to national-level efforts. To meet these needs, expenditure targeted at European public goods would need to increase from 0.4 percent of GNI to 0.9 percent.
2. Maximize the budget impact. With over 50 programs, the current EU budget is fragmented, limiting its effectiveness. Consolidating programs around core EU priorities and shifting toward a performance-based budgeting model would enhance efficiency, improve coordination among member states, and better align national reforms with EU-level objectives.
3. Strengthen financing through enhanced own resources and borrowing capacity. Establishing borrowing as a regular financing tool—backed by robust own resources for repayment—would enable more strategic, long-term investment while spreading the financial burden more evenly across time and member states.

Fourth, a more integrated Europe is also a more resilient Europe.

The spike and volatility in energy prices following Russia’s invasion of Ukraine, along with last month’s blackouts in Spain and Portugal, underscore the urgency of a coordinated European energy policy and establishing an integrated energy infrastructure.

On the financial side, advancing the capital markets union would not only channel savings into productive investment, but also facilitate portfolio diversification and significantly improve risk sharing.

Fiscal policy—particularly the EU budget—has an important role to play in supporting energy integration and risk sharing.

Let me conclude by stressing that Europe stands at a critical junction.

The world is changing, and Europe must once again demonstrate its ability to step up and deliver. Strengthening –and, yes, even upholding—prosperity requires a decisive and concerted reform push at both domestic and EU levels that enhances growth and resilience while maintaining openness to the world.

It is time to act now. It is time to act together.

References

[1] Eble, Stephanie, Alexander Pitt, Irina Bunda, Oyun Erdene Adilbish, Nina Budina, Gee Hee Hong, Moheb T Malak, Sabiha Mohona, Alla Myrvoda, and Keyra Primus. 2025. “Long-Term Spending Pressures in Europe,” IMF Departmental Papers 2025/002.

[2] Scott R. Baker, Nicholas Bloom, Steven J. Davis. 2016. “Measuring Economic Policy Uncertainty,” The Quarterly Journal of Economics, Volume 131, Issue 4, Pages 1593–1636.

[3] Boehm, Christoph E., Andrei A. Levchenko, and Nitya Pandalai-Nayar. 2023. “The Long and Short (Run) of Trade Elasticities,” American Economic Review 113 (4): 861–905.

[4] Baba, Chikako, Ting Lan, Aiko Mineshima, Florian Misch, Magali Pinat, Asghar Shahmoradi, Jiaxiong Yao, and Rachel van Elkan. 2023. “Geoeconomic Fragmentation: What’s at Stake for the EU,” IMF Working Paper 2023/245, International Monetary Fund, Washington, DC.

[5] Arnold, Nathaniel, Allan Dizioli, Alexandra Fotiou, Jan Frie, Burcu Hacibedel, Tara Iyer, Huidan Lin, Malhar Nabar, Hui Tong, and Frederik Toscani. Forthcoming. “Lifting Binding Constraints on Growth in Europe. Actionable Priorities to Deepen the Single Market,” IMF Working Paper.

[6] Budina, Nina, Oyun Adilbish, Diego Cerdeiro, Romain Duval, Balázs Égert, Dmitriy Kovtun, Anh Thi Ngoc Nguyen, Augustus Panton, and Catalina Michelle Tejada. Forthcoming. “Europe’s National-Level Structural Reform Priorities,” IMF Working Paper.

[7] Busse, Matthias, Huidan Lin, Malhar Nabar, and Jiae Yoo. Forthcoming. “Making the EU’s Multiannual Financial Framework Fit for Purpose,” IMF Working Paper.

[8] Darvas, Zsolt, and Conor McCaffrey. 2024. “Management of debt liabilities in the EU budget under the post-2027 MFF,” November 2024.

[9] Draghi, Mario. 2024. “The future of European competitiveness,” September 2024.

[10] Cimadomo, Jacopo, Massimo Giuliodori, Andras Lengyel, Haroon Mumtaz. 2023. “Changing patterns of risk-sharing channels in the United States and the euro area,” ECB Working Paper No 2849.