Yesterday, the IMF released its Spring European Regional Outlook, which projects that the current economic downturn in Europe could end during the second half of 2010, but will be followed by a slow recovery. The report emphasizes “that further policy actions, especially in the financial sector, will be essential to induce this recovery.”

The IMF believes that the banking sector "could also hold a key to the speed of the recovery in emerging Europe," in that "[m]easures to support credit, for instance through bank recapitalizations, can hold off a tightening of credit conditions, support consumption, and prevent recessions from becoming overly protracted in some countries." The report emphasizes, however, that “more forceful policy actions are required to restore market trust and confidence” and recommends that Europe follow the United States' example and conduct stress tests on individual banking institutions. Specific policy recommendations include: “continued provision of liquidity and engagement in credit easing where necessary; credible loss recognition in the financial system based on stress tests that take into account the expected deterioration in asset quality from the economic downturn; recapitalization of viable institutions, ideally by the private sector but with public support if needed, and orderly resolution of other institutions; and ring-fencing of impaired assets where they constitute a significant part of balance sheets." The report emphasizes that viable financial institutions "need to be recapitalized, with public support as needed, while others should be resolved."

The report also includes two analytical chapters, Chapter 2 entitled “Fiscal Policy in Advanced Economies: Effectiveness, Coordination, and Solvency Issues,” and Chapter 3 entitled “European Emerging Market in Crisis: Impact and Recovery.” Chapter 2 concludes that present and future “[p]olicy actions taken to address the crisis and the economic slowdown will severely burden public finances” and that, due to the “increased integration of European economies, policy coordination is key to magnifying the effects of national fiscal expansions.” The chapter also notes a “clear commitment to long-run fiscal discipline is now more essential than ever.” Chapter 3, provides an brief overview of “the impact of the global financial crisis on emerging Europe and finds that for emerging market countries that became EU members, adherence to EU rules and institutions has helped to mitigate the impact of the crisis, although it has not shielded them completely.” It notes that “the so called ‘EU halo effect’—or the phenomenon of lower bond spreads for New Member States in spite of rising vulnerabilities in some countries—has disappeared, while cross-country differences have increased.” The chapter concludes, however, “that while the external environment and structural reform efforts will matter, the banking sector, which has played a central role in the run-up to the crisis, holds a key to the speed of recovery from the crisis.”

Marek Belka, Director of the IMF’s European Department, notes that “[t]he measures taken to counteract the deep recession in Europe have provided a good foundation for a gradual recovery, but further actions by policy makers, particularly in the financial sector, are needed to restore market trust and confidence, and accelerate the recovery.” He also emphasized that “[w]hat is mostly needed is a robust approach to coordination, in particular on financial and regional macroeconomic stability,” due to Europe’s economic integration. Up to this point countries within the European Union have addressed the crisis at a national level. Mr. Belka also noted that “[w]ithout a well-coordinated effort in these areas, neither fiscal nor monetary policy efforts will work as effectively as they must to make sure that Europe is as vibrant and prosperous after the crisis as it was before.”