The new European Macroeconomic Report (EMR) has been prepared to underpin both the Euro Area Recommendation and the Alert Mechanism Report, with the goal of simplifying and broadening the reach of these key economic assessments. By merging the reports accompanying the Euro Area Recommendation and the Alert Mechanism Report, the new EMR aims to provide a macro-oriented perspective that helps identify and examine critical macroeconomic issues. With a focus on the EU as a whole and a special attention given to the economy of the euro area, the report delves into macroeconomic risks and vulnerabilities, as well as economic challenges and opportunities.
The Report analyses the economic challenges and opportunities in depth. By providing solid analysis it aims to inform strategic policy choices to strengthen the euro area and EU’s resilience in the face of a rapidly evolving global order. This year’s report is divided into four chapters. The first two chapters provide an overview of the macro-structural landscape and review the risks of macroeconomic imbalances, with special attention given to the economy of the euro area. Chapters three and four have a more thematic focus, respectively examining the allocation of savings and the macroeconomic impacts of defence spending.
As outlined in Chapter 1, despite strong headwinds in recent years, the euro area and the EU have continued to grow, albeit at a modest pace. The EU is navigating an increasingly complex international landscape, characterised by shifting geopolitical dynamics, rapid technological advancement, increasing climate risks, an aging society and low productivity (Graph 1). Yet, Member States have recovered their pre-pandemic income levels and unemployment rates have reached historically low levels (Graph 2). The EU budget, particularly the Recovery and Resilience Facility (RRF), has played a crucial role in supporting public investment and driving growth.
Graph 1: Global Economic Policy Uncertainty
Graph 2: Total and youth unemployment rates in the EU and euro area since 2000
However, growth remains constrained by sluggish productivity, which threatens the European economy's long-term prosperity and global influence. Relative to the US, both the euro area and the EU have recorded less total factor productivity (TFP) growth and less capital deepening over the past decade, implying weaker labour productivity growth (Graph 3). The rise of emerging market economies and persistently high energy costs further weigh on the competitiveness of EU producers. Supporting innovation by increasing R&D spending and leveraging human capital are crucial to unlock new opportunities and drive growth. The chapter also looks into further deepening the Single Market and expanding trade partnerships, as well as the venues for unlocking private investment to finance the Union priorities through initiatives such as the Savings and Investment Union.
Graph 3: Drivers of economic growth in the Euro area, the EU and the US
Chapter 2 investigates vulnerabilities that need to be addressed in order to ensure macroeconomic stability and balanced growth. First, the euro area and the EU have consistently run an external surplus, making them more vulnerable to external developments and hindering domestic growth prospects (Graph 4 and 5). Second, government debt dynamics are becoming more challenging as the favourable differentials between interest rates and nominal GDP growth of recent years are diminishing. Moreover, Member States face increasing defence spending needs and significant investments in the digital and decarbonisation transitions, as well as spending pressures from ageing populations. This will require prioritising spending, reassessing public finances, and rationalising spending programmes, mobilising revenue, and implementing structural reforms to boost growth. Third, the chapter also discusses how inflation differentials are a particular concern within the euro area and, if persistent, they can undermine the effectiveness of monetary policy. Finally, housing affordability has become a macroeconomic issue in many countries.
Graph 4: Current accounts in the euro area and other economies
Graph 5: Current account and NIIP for Creditors and Debtors Euro area countries
Chapter 3 discusses the euro area and the EU large external surplus and its key drivers, including high private savings. An analysis of EU capital flows shows that a significant portion of European savings originates from households, whose savings rates are higher than their international peers. European households tend to favour traditional investment channels and rarely invest directly in capital markets. Instead, most of their financial wealth is intermediated through the financial sector, which ultimately channelled about half of these savings into assets abroad in 2024, mainly the US (Graph 6). The chapter argues that the fragmentation of the European capital markets contributes to household’s savings allocation, and therefore advancing towards a genuine Capital Markets Union is therefore essential.
Graph 6: EU households' financial asset allocation vis-à-vis counterpart-sectors, adjusted flows from 2023 to 2024
The increase in government spending on defence capabilities is a critical dimension in the current geoeconomic landscape. This issue is thoroughly examined in Chapter 4. Russia’s aggression against Ukraine and adverse geopolitical developments have led to a significant deterioration of European and global security. The chapter finds that a significant expansion of industrial capacity in the EU is required to meet the new security needs. Efficient and effective spending requires a coordinated approach among EU Member States. Pooling procurement efforts could help achieve economies of scale, which would give Member States more buying power and encourage the expansion of the European defence industry’s production capacity. An increase in defence spending can be compatible with fiscal sustainability if accompanied by by reprioritising government expenditure and increasing revenue in the medium-term. From a macroeconomic perspective, the increase in defence spending may have positive effects, but this depends on several factors, such as import content, the degree of frontloading, the share of infrastructure and R&D spending, and the level of debt financing. New model simulations suggest that meeting NATO's updated spending target could moderately increase GDP in the euro area and the EU (Graph 7 and 8).
Graphs 7 and 8: QUEST simulation results, reaching the NATO 5% of GDP target by 2035, EU27
