Europe faces growing fiscal challenges as new public spending demands and slow economic growth put pressure on government budgets, according to a recent address at the House of the Euro in Brussels. The event, hosted by the European Central Bank (ECB), focused on how Europe can manage increasing costs that current resources may not cover.
The speaker highlighted that while Europe has weathered several crises—including the pandemic and Russia’s invasions of Ukraine—growth prospects remain weak. "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," they said.
Recent forecasts from October show a slight upgrade for euro area growth in 2025 to 1.2 percent, but this improvement is expected to be temporary. Export reversals and tariffs are likely to affect profits moving forward. Medium-term projections indicate continued sluggishness, with EU GDP per capita nearly 30 percent below that of the United States—a gap that could widen without reform.
European policymakers acknowledge these issues but have made limited progress so far. The speech emphasized: "This needs to change."
The fiscal outlook is complicated by rising demands for defense and energy security spending, as well as ongoing pressures in pension and health care systems. By 2040, advanced European economies (excluding Central, Eastern, and Southeastern Europe) are projected to face additional spending needs equivalent to 4½ percent of GDP; for CESEE countries, this figure rises to 5½ percent.
At the same time, higher bond yields combined with existing debt levels are increasing interest payments across many countries. Weak labor supply and growth further limit revenue collection.
"Doing nothing is not an option!" warned the speaker. Simulations suggest that if current policies persist, average public debt ratios could climb steeply—reaching 130 percent by 2040 across European nations.
To keep debt sustainable—defined here as not exceeding 90 percent of GDP—the region would need significant fiscal adjustments or reforms. Without reforms, reducing deficits enough would require annual cuts close to one percent of GDP for five years—a total adjustment much larger than past consolidation efforts in Europe.
"As any Minister of Finance will tell you, a sustained fiscal effort generating 3 percent of savings is an enormous political endeavor," noted the speaker. "5 percent is an almost impossible feat and would require deep cuts into the European model and social contract."
Moderate reforms could ease this burden somewhat by lowering needed adjustments from around five to just above three-and-a-half percent of GDP cumulatively through measures such as structural changes or improved efficiency.
However, even after moderate reforms, about three-quarters of European countries will still need further consolidation efforts beyond what has been outlined in their official plans under EU rules—which currently fall short by roughly two percentage points of GDP compared with these estimates.
More ambitious reforms could help narrow Europe's income gap with the U.S., reducing future fiscal strain. Yet for some high-debt countries even combined reform and consolidation may be insufficient; they may face difficult decisions regarding government scope or funding models for public services.
Options include introducing user fees for certain services while protecting low-income groups or designing progressive tax reforms—especially relevant for CESEE nations with more potential for raising revenues—or privatizing state-owned enterprises (SOEs) where appropriate.
If all European countries reduced public financing shares in sectors like health care or infrastructure down to OECD averages, savings could reach up to three percent of GDP on average.
"There are no silver bullets," concluded the speaker. "For most countries, the policy package will be a mix of reforms and consolidation." They stressed strategic planning over incremental measures: "Tinkering at the margins will likely not be sufficient... Instead, a carefully-selected set of significant reforms and sizable consolidation measures will be needed."
Success depends on clear communication about reform goals among stakeholders—and careful sequencing—to maximize benefits while minimizing resistance: "These steps will be key...to meet the fiscal challenge and build a more prosperous and stable economy for all."