How can Europe Pay for Things it Cannot Afford? sitecoreitem

How can Europe Pay for Things it Cannot Afford?

November 4, 2025

As prepared for delivery

Thank you, [Mr. Kisselevsky], for the kind welcome and the ECB for hosting us again here in Brussels at the House of the Euro.

The year 2025 marked a period of profound transformation in the global economy, driven by a reconfiguration of trade policies.

For Europe, these developments follow a series of crises-from the pandemic, to Russia's invasions of Ukraine-that have tested the region's resilience.

Timely policy action has helped avoid the worst, and Europe continues to grow-but it is now becoming evident that Europe faces very low growth over the medium term.

My message today is that this has major implications for the fiscal challenges Europe is facing. In short, unless Europe steps up in a major way to lift growth to another level, traditional fiscal consolidation measures will not be enough to prevent debt levels from becoming explosive, putting Europe's social model at risk.

But let me begin by setting the stage and discuss our baseline outlook.

In our just released October forecast we have slightly upgraded our forecast for 2025 for the euro area to 1.2 percent. But the improvement is short-lived, and we see several factors dampening the recovery in 2026.

The large front-loading of exports to the U.S. earlier this year is reversing and uncertainty remains. The effects of tariffs on exports will increasingly be felt as profits are squeezed.

The preliminary flash estimate for Q3 released last Thursday is broadly in line with this forecast.

Our medium-term forecast expects mediocre growth, due to persistent challenges that will continue to constrain Europe's economic dynamism. Today, the EU's GDP per capita is nearly 30 percent lower than that of the U.S., and without meaningful reform, this gap could become even larger.

Let me highlight three key areas:

• Structural Barriers: Intra-EU trade barriers remain high-equivalent to 44 percent for goods and 110 percent for services. Regulatory frictions slow cross-border mobility of capital and labor. And the lack of a unified energy market keeps costs up and weakens energy security and resilience.
• Demographic Headwinds: Europe's population is aging. By 2050, over two-thirds of EU countries will see a decline in their working-age population. This gives urgency to the reform agenda around labor markets and skills.
• Investment Gaps: In some countries, especially in the CESEE region, large investment gaps are depressing labor productivity and growth, pointing to the importance of both EU-level and domestic reforms to deepen capital markets and incentivize private investment.

European policymakers recognize the urgency to act. But progress has been slow, at best. This needs to change.

This brings us to the question, "how Europe is going to pay for the things it cannot afford?"

We are all familiar with the difficult fiscal landscape in the region, with high debt in many countries, and pressures on public spending levels.

But the actual fiscal situation is worse. Europe's fiscal challenge will become even more pressing, for several reasons.

First, new demands on public spending have emerged, in defense, and for energy security. This adds to spending pressures accumulating in pension and health care systems.

Overall, we estimate additional spending in these four areas of 4½ percent of GDP in Advanced Europe including the UK but excluding CESEE economies (AE excl CESEE) by 2040, and 5½ percent of GDP in CESEE countries.

Second, rising bond yields are combining with high debt levels to create a rising interest bill in many countries.

Third, the mediocre outlook for medium-term growth and labor supply weighs on revenue collection and puts upward pressure on debt levels.

What is abundantly clear is that doing nothing is not an option!

Our simulations show that, under current policies, public debt would be on a steeply-increasing path over the next 15 years. The average debt ratio across European countries could reach 130 percent by 2040.

How big of a problem is this?

For the purposes of our simulations, we use a sustainable reference debt path that-over the longer term-does not exceed 90 percent of GDP. This benchmark reflects increased debt-carrying capacity in many countries over the past three decades.

It suggests an enormous sustainability gap: if no action is taken, by 2040, average debt ratios could be 40 percentage points above sustainable levels. If the debt path was anchored around debt of 60 percent of GDP, as is still embedded in the European fiscal framework, the gap would reach an even more daunting 70 ppts of GDP.

So, the question is, how to prevent debt from becoming rapidly unsustainable, while absorbing rising spending pressures?

A sustainability gap that large is hard to address by conventional fiscal consolidation alone. Without reforms, the amount of deficit cutting needed to bring debt in line with the reference path would be almost 1 percent of GDP per year for five years, or cumulatively almost 5 percent of GDP.

This would go far beyond what past consolidation efforts in Europe have delivered. On average, successful consolidation campaigns have yielded cumulative savings of just about 3 percent of GDP and lasted only about 3-4 years.

As any Minister of Finance will tell you, a sustained fiscal effort generating 3 percent of savings is an enormous political endeavor. 5 percent is an almost impossible feat and would require deep cuts into the European model and social contract.

The way out is to accelerate growth. In our analysis, we show that even a set of moderate reforms can make a difference. It includes:

• growth-enhancing domestic reforms closing one quarter of the gap to the best performers;
• taking first steps to deepen the single market and increase the EU budget for public goods like innovation and defense, funded through joint borrowing;
• pension reforms that help to stabilize spending;
• and measures to catalyze private investment through public investment banks.

This moderate set of reforms on its own would lower the cumulative fiscal adjustment needs from around 5 to slightly above 3.5 percent and bring the average debt path one third of the distance to the sustainable path.

Not all countries are the same, and some have lower starting levels of debt or less fiscal pressures to deal with. But we calculate that around three-quarters of European countries will need to consolidate, after implementing the "moderate" set of reforms.

The amount of required consolidation implied by our illustrative exercise is notably larger on average than what has been committed to in the Medium-Term Fiscal and Structural Plans under the EU fiscal framework. For instance, the average adjustment under submitted and signed off plans would fall about 2 percent of GDP short of our estimates.

But let me be clear that more reforms could change this picture. In forthcoming work, we show that an all-out reform effort can make a significant contribution to closing Europe's GDP per capita gap with the U.S. This would obviously lower the need for fiscal consolidation compared with the scenario we have modeled here.

For some countries with already-high debt levels, our simulations show that a combination of reform and conventional consolidation may not be enough to keep debt sustainable.

We find that around one quarter of European countries would need fiscal consolidation of above one percent of GDP per year for five years, after implementing the "moderate" set of reforms. As mentioned, this is more than what has proved feasible in the past.

These countries will therefore face difficult choices about the scope and ambition of government given the available resources.

In some cases, this may mean a discussion about the social contract underlying the "European model."

For example, if resources are truly limited, providing public services fully without cost might no longer be affordable. Instead, private financing could be increased while protecting the most vulnerable. This could be done by charging user fees for some services, like health care, while keeping the services free for those on low incomes.

Large tax reforms can also be designed in a progressive way, which is particularly relevant for CESEE countries, which have more scope for revenue mobilization. Privatization of SOEs is another option in these countries to create fiscal space, that doesn't necessarily have to impact those on the lowest incomes.

The potential savings from these more fundamental changes are substantial. For instance, if all European countries were to reduce the share of public financing in health, education, pensions, infrastructure and energy security, to the OECD average, then this could generate savings of up to 3 percent of GDP on average.

So what does this analysis tell us about how Europe can pay for these things that are hard to afford?

Well there are some key takeaways.

One, there are no silver bullets. For most countries, the policy package will be a mix of reforms and consolidation.

Second, it's time to stop muddling through and be more strategic. Tinkering at the margins will likely not be sufficient to keep debt sustainable, but can still generate political opposition. Instead, a carefully-selected set of significant reforms and sizable consolidation measures will be needed to bridge the gap.

Finally, the approach to the reform process will be critical to maximize its chances of its success. Its purpose will have to be well communicated, with dialogue between relevant stakeholders, to highlight the economic and social benefits of avoiding a more painful and disorderly correction forced by financial market pressure. Different parts of the policy package can be bundled together, to increase net benefits to key constituencies, with careful sequencing so that the burden of reform does not become overwhelming.

These steps will be the key to a durable policy package, that meets the fiscal challenge, and builds a more prosperous and stable economy for all.