By Conny Olovsson and Alexander Popov
The economist Robert Lucas famously wrote that “Once one starts to think about economic growth, it is hard to think about anything else.” The Nobel committee seems to agree. For the second year in a row, it has chosen to honour work on economic growth. This ECB Blog post looks at the research of this year’s laureates.

Last Monday, the Royal Swedish Academy awarded the Sveriges Riksbank Prize in Economic Sciences to three laureates. The committee singled out Joel Mokyr “for having identified the prerequisites for sustained growth through technological progress”, and Philippe Aghion and Peter Howitt “for the theory of sustained growth through creative destruction”. The winning research is highly relevant for the euro area economy. Just recently, for example, Philippe Aghion took part in a discussion at the ECB Forum on Central Banking on how to tap Europe’s growth potential. He also co-authored an earlier ECB Blog post on Europe’s prospects of becoming a green technology leader.
While differing somewhat in both method and scope, in their overall body of work the three laureates take on some of the biggest questions an economist can ask: why do some countries grow faster than others? How can countries not only achieve economic prosperity, but also maintain it?
Their answer to these trillion-dollar questions can be summed up in one word: technology, emerging from an ever-expanding pool of ideas and knowledge. When first proposed in the 1960s, this notion represented a quantum leap. Earlier models of economic growth, such as the canonical one by Robert Solow (himself a Nobel Prize winner in 1987), took technological progress as given. Economists, known for their love of Greek words, call this process “exogenous”, or “from outside”. In contrast, the ever-growing strand of research that formalized the genesis and rise of new technologies (including the 2018 Nobel Prize winner Paul Romer’s pioneering model of R&D-driven growth) looks at “endogenous” growth, or growth generated “from inside”. Standing on the shoulders of giants, this year’s laureates have built on that legacy.
The lessons of the Industrial Revolution
The economic historian Joel Mokyr has studied the question of how growth came about and took hold through the lens of the Industrial Revolution,[1] arguably one of the most interesting economic episodes in human history. For millennia, standards of living remained consistently flat. Economic growth was limited and temporary (i.e. it was not “sustained”). However, at some point in the late 18th and early 19th centuries, the world entered a phase of sustained growth and rising living standards (see Chart 1).[2] It was obvious that the striking growth in income ushered in by this event was spurred by dramatic technology-driven improvements to labour productivity. And yet, back when Mokyr was embarking on his academic career, it was far from clear why the Industrial Revolution happened when it did. Even more puzzling was why it happened in Europe and not in China or India, each of which accounted for a larger share of global GDP in the mid-18th century.
Chart 1

Global average GDP per capita over the long run

Source: Our World in Data

Mokyr came up with an answer that can be summarised as follows: for sustained economic growth, new technologies must not only be invented, but also taken up and maintained. Because existing elites often push back against technological innovation, new ideas must take root quickly. Otherwise, they can fade away. Take the steam engine, often seen as the paradigmatic invention of the Industrial Revolution. First of all, someone had to come up with the idea of a new apparatus able to transform heat energy into mechanical work. Second, and crucially, the device had to be both practical and profitable. To this end, new equipment had to be built, installed, operated, maintained and repaired. This had to be done by expert craftsmen. In an age in which machinery was custom-made, all of this depended on a trained and experienced workforce.
And it is here that Europe – and England in particular – excelled in the early 19th century. It could draw on a critical mass of artisans and engineers. Mokyr calls the members of this class “Upper Tail Human Capital”. These were not the social elites, who were educated but uninterested in technological progress, nor the common workers, who were largely illiterate, but rather those who were open to new ideas and educated enough to understand new technologies and spread the word. Thanks to its apprenticeship structures, its world-class universities, its numerous scientific societies and its penchant for publishing and exchanging ideas, England had built up a critical mass of scientists and craftsmen who not only talked among themselves and worked together, but who also transformed these ideas into commercial products. This gave rise to the knowledge and skills that were the chief source of technical human capital in this age. Between 1750 and 1825, English industry became a hotbed of innovation. And it emerging as an unrivalled market for applying and improving on new ideas.
Mokyr’s major contribution is thus that economic growth through technological innovation depends on generating new ideas and on maintaining knowledge that can then be passed on. In contrast, before the Industrial Revolution, many useful technologies were deployed without any real understanding of how or why they worked. Mokyr also points out that new inventions often replace old technologies and can thus disrupt existing ways of working. New technologies tend to face resistance from entrenched groups who see their privileges under threat. For sustained growth to take hold, societies must therefore be open to new ideas, allow intellectual exchange and support the incremental build-up of both scientific and engineering expertise.
The role of “creative destruction”
While Mokyr’s work makes a historical case for the primacy of ideas and knowledge in enabling technological progress, Aghion and Howitt take this further. They drill into the precise mechanisms whereby innovation generates economic growth.
The core ideas for which they were honoured by the Nobel committee can be found in their landmark 1992 paper.[3] Here, they took an old idea from Joseph Schumpeter – that capitalism advances through constant disruption – and used it to build a rigorous economic model.
In their framework, growth does not happen smoothly or automatically. Rather, it is driven by a never-ending race to innovate. Entrepreneurs and firms invest in research and development because the rewards are big: a successful innovation temporarily brings extraordinary rewards – so-called monopoly profits – until everyone else catches up. But every successful new technology also wipes out the value of its predecessors – “creative destruction” in the world of Aghion and Howitt. In contrast to Romer’s model, where growth comes from the creation of new product varieties, in their model growth arises from a continual process of quality-improving innovations whereby old technologies are replaced by new ones, which build and expand on prior knowledge. So it is that innovation creates economic value not only for the innovators, but also for society as a whole. And this motivates subsidies to R&D.
This churn is both the engine and the cost of progress. Innovation raises productivity and living standards. At the same time, it destroys existing firms, displaces workers and leads to periods of adjustment. Growth, in other words, is not painless, and progress goes hand in hand with turbulence.
The policy implications are complex. For example, in a highly competitive environment the pay-off from investing in innovation soon disappears, making innovation unprofitable. Weak competition, meanwhile, also deters innovation because monopolists do not feel threatened enough to innovate. Stronger patent rights can spur innovation, but too much protection can entrench monopolies and slow the pace of change. A careful combination of competition, openness, subsidies and social insurance is therefore needed to keep the engine of creative destruction running.
These ideas have a wide range of real-world applications. For example, in his later work[4] Aghion combined the idea of “creative destruction” with climate modelling. Here, he showed the benefit of subsidising research on green technologies until clean energy can outcompete dirty energy, demonstrating how his theories can be applied to the “green transition”.[5] Today, the ongoing resource-intensive “gold rush” in Artificial Intelligence among a few very innovative companies running neck-and-neck with each other bears out the Schumpeterian notion that innovation – regardless of how useful it ultimately turns out to be – is at its best when a market is neither monopolistic nor overly competitive.
In defence of science, technology and growth
This year’s Nobel laureates teach us an important lesson: sustained growth cannot and should not be taken for granted. Indeed, for most of human history economic stagnation was the norm. Overall, their work warns us to take heed of the factors that can impede or even destroy economic growth. These include monopoly power, restrictions to expanding knowledge and bad economic policy.
This year’s award also comes on the heels of the 2024 Nobel Prize awarded to Daron Acemoglu, David Robinson and Simon Johnson. Their work underscored the key role played by competent and independent institutions – for instance, by protecting property rights, placing constraints on the power of elites and ensuring credible, predictable, and rule-based policy – in generating and maintaining growth and prosperity. It is rare to see two consecutive awards for research on such similar topics. It is almost as if the Nobel committee is sending out a warning to a world that has seemingly grown sceptical of science and weary of technology and is all too willing to entertain the idea of degrowth.
The lessons for us Europeans could not be clearer. A mere century ago, Europe was home to some of the world’s most innovative companies, its top universities and its deepest capital markets. But the continent that gave rise to the Industrial Revolution is today seen as a growth laggard and an example of how technological progress can be squandered. To regain Europe’s reputation for economic excellence, we need to boost innovation and competitiveness through increased R&D investment and streamlined regulation that supports business dynamism. And we need to do so even at the cost of some disruption. All of which, incidentally, very much chimes with the conclusions from last year’s Draghi report.[6] This year’s Nobel Prize winners would no doubt agree.
The views expressed in each blog entry are those of the author(s) and do not necessarily represent the views of the Riksbank, the European Central Bank or the Eurosystem.
Check out The ECB Blog and subscribe for future posts.
For topics relating to banking supervision, why not have a look at The Supervision Blog?

See, e.g. Mokyr, J. (1990), The Lever of Riches: Technological Creativity and Economic Progress; Mokyr, J. (2002), The Gifts of Athena: Historical Origins of the Knowledge Economy; and Mokyr, J. (2016), A Culture of Growth: The Origins of the Modern Economy.
While economists typically measure economic growth in terms of changes in GDP, note that growth also includes other aspects such as new medicines, better food, safer cars and many other improvements in welfare.
Aghion, P. and Howitt, P. (1992). “A Model of Growth Through Creative Destruction”, Econometrica 60, 323—351.
Acemoglu, D., Aghion, P., Burzstyn, L. and Hemous, D. (2012), “The Environment and Directed Technical Change.” American Economic Review 102, 131—166.
For an expansion of this model, accounting for the role played by financial markets, see https://www.ecb.europa.eu//pub/pdf/scpwps/ecb.wp2686~c5be9e9591.en.pdf.
https://commission.europa.eu/topics/eu-competitiveness/draghi-report_en

 
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Speech by IMF Managing Director Kristalina Georgieva at the 2025 Annual Meetings Plenary
Deputy Prime Minister Olavo Correia, thank you, and may my future travels take me to the beautiful shores of Cabo Verde and the soulful melodies of Cesária Évora—or perhaps even to a football victory chant! Congratulations to your national team for qualifying for the World Cup for the first time in your country’s history!
Dear Ajay, I cannot think of a better partner to have at the Bank than you! Thank you for your remarks and for your total and tireless focus on jobs.
As you point out Ajay, the world confronts a great demographic divide. Let’s look at a world map: first, we see a set of countries grappling with aging and shrinking populations; then, a group in the middle; and finally, large sections of Africa and parts of the Middle East and Central Asia where population growth is surging, as is a youthful workforce.
To our global membership, a very warm welcome—and let me state upfront that any insights I may share with you today reflect the collective wisdom of the IMF’s talented and dedicated team coming from 172 countries.
All IMF management and staff in this hall: please stand and be recognized—from our brand new First Deputy Managing Director Dan Katz, to the rest of our senior management team, to all!
***
Since we last met here in this big hall on October 25, 2024, uncertainty has shot up-up-up—yet global sentiment is holding. In other words, we have a mix of anxiety and resilience. Today I would like to reflect on both.
First, the anxiety.
From technology to geopolitics to climate to trade, change is unsettling. The world trading system that delivered so much for so many is being shaken to its core—for many reasons, including because the playing field wasn’t truly level and the people left behind received too little help in retooling for new and better jobs.
We see assertive nontariff measures ranging from import licensing to export controls and port fees, with subsidy counts capturing only part of the picture. We see non-market industrial policies and exchange rate distortions.
And, of course, we have U.S. tariff rates shooting up this year. But here is a key fact: 188 of our 191 member countries have so far avoided tit-for-tat tariff actions.
Having noted that trade barriers hurt both growth and productivity, and having urged policymakers to preserve trade as an engine of growth, I welcome this restraint by most countries—although surely there will be more changes to come.
At this point, despite all the turbulence, an estimated 72 percent of world trade is still being conducted on most-favored-nation terms: countries take their lowest bilateral tariff rate and offer it to all of their trading partners. Simple, not complex.
Trade is not a zero-sum game. Provided firms can maintain diversified and robust supply chains, provided governments can retain their strategic autonomy and assist those who lose out from trade, and provided external balances are not unsustainably large, imports and exports enhance welfare. No wonder the current uncertainty around trade policies and the risk of losing trade as an engine of growth are creating anxiety.
So let me rotate to the resilience.
Despite the sweeping policy shifts we have seen this year, and defying many expert predictions, the global economy has held up reasonably well thus far. World growth is projected to slow from 3.3 percent last year to 3.2 percent in 2025 and 3.1 percent in 2026—slower than needed and below what we forecast one year ago, but not a dramatic slowdown.
One reason for this resilience has been private sector adaptability, as seen in the import frontloading, the stockbuilding, and the supply-chain strengthening. Years of robust profits have allowed exporters and importers to squeeze margins, cushioning the price impact of higher tariffs on consumers, at least for now.
The other reason is more of a double-edged sword: private sector investment in artificial intelligence, especially in the U.S., is booming. This is propping up U.S. and world growth and delivering supportive financial conditions for all.
This is where optimism—in this case about the genuine potential of AI—risks becoming complacency.
From the railways to the internet, the history of financial market responses to pathbreaking new technologies is a story of overestimation and market correction—here, for instance, we see a snapshot of the dotcom episode and its impact on growth. The world would be wise to manage such risks.
How? We need strong financial sector oversight, alert to excessive risk-taking and the growing links between banks, nonbanks, and crypto, and we need judicious monetary policy.
This and other cross-cutting advice punctuate our multilateral surveillance, where our World Economic Outlook, Global Financial Stability Report, and Fiscal Monitor—all released this week—shine light, lower the temperature, and propose a path forward.
Our bilateral surveillance, delivered via regular consultations with all our member countries—advanced, emerging, and low-income alike—as well as our Financial Sector Assessment Program, distills our multilateral advice into tailored policy recommendations country by country.
In meeting after meeting this week, I have advised finance ministers and central bank governors not only to mitigate the near-term risks but also to look beyond them—preserving independent, accountable, and effective institutions, and finding, capturing, and delivering the opportunity that change always brings.
We see three medium-term objectives:
• One, repairing governments’ finances. This is necessary so they can buffer new shocks and attend to pressing needs without driving up private sector borrowing costs. No finance minister should simply wait for faster growth to come to the rescue. On the contrary, fiscal consolidation can release resources to support private sector-led growth.
• Two, domestic and external rebalancing. This is necessary to ensure that excessive macroeconomic imbalances do not emerge as a spoiler. We need fiscal consolidation in some places, and policies to lift domestic demand in others.
• And three, lifting trend growth. This is essential for economies to generate more jobs, more public revenue, and better public and private debt sustainability.
Lifting growth requires three things: one, regulatory housecleaning to unleash private enterprise; two, deeper regional integration; and three, preparedness to harness AI.
Regulatory housecleaning and regional integration are closely interlinked, including because many of the rules and regulations that tie down private enterprise at home also restrict the movement of goods, services, people, capital, and ideas across borders—many regulations double up as nontariff barriers, and nontariff barriers are a key part of the unlevel global playing field.
In this new world of bilateral and plurilateral dealmaking, we see a diverse global trading landscape. Economies that are small and reliant on exports are at the receiving end of others, while those that are large and relatively less open—or control critical inputs to global supply chains—have negotiating power. Looking at this splash of dots showing countries by size of imports and trade openness, the bottom right quadrant is where we find the largest, least open economies.
Many countries are seeking to build strength and find voice through cohesion. Here we see a selection of the world’s trading blocs, each enjoying more size and heft than its member countries individually. Our advice to the world’s trading blocs? Reduce your internal frictions and press forward with integration for resilience and growth.
Finally, the other potential accelerator of global productivity growth is artificial intelligence. We at the Fund expect real gains, but our estimates are in a wide range—a global productivity growth uplift of 0.1–0.8 percentage points per year.
AI will also take away millions of today’s jobs, and policymakers need to help ease the transition. Old professions will fade. New ones will rise: big-data specialists, fintech engineers, machine-learning experts, and so on. Such churn is not uncommon. Recall how the automobile replaced the horse and buggy.
The key to maximizing the productivity gains and managing the fallout of AI is preparedness. Our research finds Singapore, the U.S., and Denmark in the lead, while many others trail behind. As a transmission line for global best practice, the IMF will assist all members, with a focus on managing the macroeconomic implications.
***
Internally, we are of course pressing forward with AI adoption of our own—including to put more knowledge at the fingertips of our members.
We are enhancing our productivity while preserving our trademark budget discipline. The IMF covers its operating expenses from own revenues—with zero reliance on annual appropriations—and maintains a deep commitment to leanness.
Despite the increasing complexity of the world economy and the expansion of the services we provide to our members, our administrative spending today is about the same size as 20 years ago.
Our work in capacity development includes operational advice, with almost 3,000 projects delivered in the last year; training, with over 500 courses serving over 19,000 officials over the same period; and convening, which last February included our first-ever emerging market conference, in Al Ula, Saudi Arabia, co-hosted with Minister Al‑Jadaan.
Our lending activity, anchored by macroeconomic adjustment and conditionality, currently includes programs with 43 countries, with $37 billion approved since last October, of which almost $5 billion has been to nine low-income countries.
In an uncertain world, a well-resourced IMF is essential. In that regard, let me today repeat two requests to our members:
• First: on our quota base. We are pressing to get the 50 percent quota increase agreed last year across the finish line. I ask all member countries that have not yet ratified the increase to please do so expeditiously.
• Second: on our Poverty Reduction and Growth Trust, our main vehicle for concessional lending to low-income countries. We are pressing forward with the reforms agreed last year to put the PRGT on a path to self-sustainability, which include, one, distributing up to $9.4 billion to an interim account over a five-year period and, two, getting to a point where 90 percent of the principal in this account is promised to the PRGT. To date, 20 countries—most recently India and, just yesterday, China—have provided assurances totaling 43 percent. But broader support from the membership remains essential to reach 90 percent. I ask you for this support.
Finally, there is one further matter that I want to bring to your attention, and that is the Catastrophe Containment and Relief Trust—CCRT—our vehicle to provide grants to help low-income member countries pay debt service owed to us if they face natural or public health disasters. Quite rightly, the CCRT was depleted during the pandemic.
Our ambition must be to remain able to assist our poorest members when they face situations beyond their control. The amounts needed here are in the millions, not billions, and would make a huge difference. So now, as you return to your capitals, I ask you this: please consider opening a discussion on CCRT replenishment, for the greater good.
***
Let me end with something lighter.
In March last year, I gave a speech at Cambridge University on “The Economic Possibilities For My Grandchildren” in which we animated some famous words from the great John Maynard Keynes—here we have that synthetic audio again.
And now, 18 months later, please see our new AI avatar of Mr. Keynes, strolling casually through this very hall!
No better way to end than with this little bit of fun, I think: despite all the anxiety that change brings, let us be optimistic! Let us feel our spirits lifted by the human progress that the coming year will surely bring!
Thank you!
 
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By Pauline Avril, Maciej Grodzicki, Lukas Jürgensmeier and Alessandro Ricci

Banks have bought back over €60 billion of their own shares since 2020, which is a sign of the industry’s confidence. However, share buybacks can also reduce the capital banks have available for potential crises. This blog post examines how euro area banks’ share prices reacted to these buybacks.

Share buybacks indicate that a bank’s management is confident in its financial soundness and future prospects. Also, buybacks are subject to approval from a bank’s supervisors. By reducing equity, share buybacks mechanically increase the return on equity, which investors may see as a positive sign. However, by decreasing capital buffers, buybacks can reduce a bank’s safety margin, potentially leading to adverse market reactions. That’s why share buybacks matter from both a supervisory and a financial stability perspective.
Why do banks buy back their own shares?
Share buybacks can be particularly appealing to investors when a bank’s price-to-book ratio is below 100%. This means the market considers the bank to be worth less than the total value of its net assets. In some cases, this could indicate that a bank is close to financial difficulty or that investors doubt that the bank’s assets are accurately valued. More often, however, a price-to-book ratio below 100% suggests that the bank cannot earn the cost of capital committed by investors. For investors, a buyback can be an opportunity to reallocate capital to other investments which offer a better trade-off between risk and expected returns.
However, when the price-to-book ratio is above 100%, the higher valuation indicates that the bank is generating returns above its cost of capital. In this case, shareholders are likely to benefit if the bank reinvests its earnings in the business rather than paying them out. In other words, buybacks are less appealing when the share price is above the book value.
To understand how markets react to banks’ share buybacks, we use an event study approach. Specifically, we look at market price movements – share prices and volatility – around the dates when share buybacks are announced and executed. This blog post summarises the main findings.
Share buybacks by euro area banks: key facts
Between 2020 and 2024, 21 large, publicly listed euro area banks included in the EURO STOXX Banks Index announced 75 buyback programmes. Through these programmes, the banks returned €61.6 billion of capital to shareholders. In this timeframe, on average, each bank that bought back its own shares distributed 8.35% of its Common Equity Tier 1 (CET1) capital as of the first quarter of 2020.
As profits increased over this period, banks steadily expanded the total size of the buyback programmes each year – measured in both absolute and relative terms (Chart 1, panels a) and b). The rise in the value of buybacks also came with more frequent buyback announcements, which increased each year until 2023 (panel c). Finally, the growing magnitude of buybacks has coincided with the increasing bank profitability, illustrated by the rising return on equity (panel d).
Chart 1­­

Overview of executed share buyback programmes and profitability by year

Sources: Bloomberg, ECB calculations.
Notes: Based on a sample of 21 listed euro area banks included in the EURO STOXX Banks Index. Panel d): simple average of the sample banks’ return on equity.

How did markets react to the announcement of banks’ buybacks?
Our analysis shows that when a bank announces a share buyback, its share price increases by 2.5% relative to the EURO STOXX Banks Index in the five trading days following the announcement (Chart 2, panel a). This measure, called the abnormal return, ensures we do not wrongly attribute changes affecting the share prices of the entire industry to an individual bank’s share buyback announcement. For context, the benchmark index yielded an annualised return of 8.7% over the same period. This highlights that share buybacks accounted for a significant part of total returns on bank shares.
As 43% of buyback announcements coincide with the release of quarterly earnings reports, i.e. earnings calls, our analysis distinguishes between these events. Therefore, we separated the effect of buyback announcements from earnings news. The findings indicate that cumulative abnormal returns follow the same pattern, whether or not the buyback coincides with earnings calls (Chart 2, panel b). This suggests that the effect of buybacks continues even when factoring in other market-relevant announcements.
We also found that the effect of buyback announcements depends on the bank’s price-to-book ratio (panel c). As we would expect, the positive impact of buyback announcements on share prices is stronger for banks trading below book value than for those with price-to-book ratios above 100%.
Chart 2

Buyback announcements – short-term effect on cumulative abnormal returns

Source: ECB calculations.Note: Vertical lines represent the 95% confidence intervals.

Contrary to the effect on share prices, the impact of buyback announcements on implied share price volatility – a measure that quantifies the market’s expectations about the share’s future volatility – varies depending on whether these announcements coincide with earnings calls. As shown in Chart 3, panel b), stand-alone buyback announcements lead to a temporary increase in share price volatility. This reaction is plausible, because the announcement conveys new information for the market to digest.
However, when buyback announcements coincide with earnings calls, they are associated with a decline in share price volatility. This effect is consistent with the literature on earnings announcements,[1] which shows a decrease in volatility immediately after an announcement.
Chart 3

Buyback announcements – short-term effect of buyback announcements on implied volatility vs. the day before the announcement

Source: ECB calculations.
Note: Vertical lines represent the 95% confidence intervals.

How did markets react to the execution of banks’ buybacks?
When companies deal in their own shares, it can distort share prices. To address this, the EU Market Abuse Regulation provides safeguards aimed at limiting the market impact of buyback trades.[2] To avoid conflicts of interest, banks usually outsource the repurchase of shares to an independent broker or a separate business unit.
That is why we also examined whether executing a share buyback has an impact on the share’s price and volatility. Specifically, we evaluated whether there is a relationship between the number of shares repurchased (as a share of the daily trading volume) and (i) abnormal returns and (ii) implied volatility.
The sample used for this analysis differs from that used in the previous section. Given limited data accessibility, we use transaction-level data on the share buybacks carried out by four large euro area banks between 2020 and 2024. These data are publicly available on the banks’ websites.
Overall, we find no difference in abnormal returns between days with and without share buybacks (Chart 4, panel a). Furthermore, an econometric analysis confirms no statistically significant relationship between abnormal returns and the share of buyback trades in total trading activity. Together, these findings indicate that the execution of share buybacks does not systematically affect share prices.
Brokers responsible for executing buybacks are often rewarded for buying back shares at a lower average price. When a share’s price drops, brokers are incentivised to buy more shares. These purchases could explain why buyback execution is associated with lower share price volatility (Chart 4, panel b).
Chart 4

Distribution of abnormal returns and implied volatility on trading days with and without share buyback executions

Source: ECB calculations.

Overall, the results of our study are largely consistent with the relevant literature.[3] The positive market reaction to share buybacks is stronger for banks whose shares trade below book value. This supports the signalling hypothesis, according to which a buyback programme is a sign that management and regulators have greater confidence in the bank’s financial health. Our results also show that, for the sample of four large euro area banks, buyback trading activity does not have an undue impact on market prices – which is in line with the objectives of the Market Abuse Regulation.
The views expressed in each blog entry are those of the author(s) and do not necessarily represent the views of the European Central Bank and the Eurosystem.
Check out The ECB Blog and subscribe for future posts.
For topics relating to banking supervision, why not have a look at The Supervision Blog?

See Donders, M., Kouwenberg, R., Vorst, T. (2000), “Options and earnings announcements: an empirical study of volatility, trading volume, open interest and liquidity”, European Financial Management, Vol. 6, Issue 2, pp. 149-171, and Dubinsky, A., Johannes, M. Kaeck, A. and Seeger, N. (2019), “Option pricing of earnings announcement risks”, The Review of Financial Studies, Vol. 32, Issue 2, pp. 646-687.
Regulation (EU) No 596/2014 of the European Parliament and of the Council of 16 April 2014 on market abuse (market abuse regulation) and repealing Directive 2003/6/EC of the European Parliament and of the Council and Commission Directives 2003/124/EC, 2003/125/EC and 2004/72/EC (OJ L 173, 12.6.2014, p. 1), and Commission Delegated Regulation (EU) 2016/1052 of 8 March 2016 supplementing Regulation (EU) No 596/2014 of the European Parliament and of the Council with regard to regulatory technical standards for the conditions applicable to buy-back programmes and stabilisation measures (OJ L 173, 30.6.2016, p. 34).
See Webb, E. (2008), “Bank stock repurchase extent and measures of corporate governance”, International Journal of Managerial Finance, Vol. 4, Issue 3, pp. 180–199, and Andriosopoulos, D. and Lasfer, M. (2015), “The market valuation of share repurchases in Europe”, Journal of Banking and Finance, Vol. 55, pp. 327-339.

 
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Executive Summary:
Economic growth in Europe and Central Asia (ECA) has slowed but the region has remained resilient amid continued global and regional challenges. Regional gross domestic product is likely to grow by 2.4 percent in real terms this year, down from 3.7 percent in 2024, because of a weaker pace of expansion in the Russian Federation. Excluding Russia, which accounts for about 40 percent of the region’s output, growth is likely to remain little changed at about 3.3 percent this year and next. Growth in Türkiye and Poland is set to strengthen to 3.5 percent and 3.2 percent, respectively, supported by strong consumer demand and robust investment growth. The pace of economic expansion in Central Asia—ECA’s fastest growing subregion for the third consecutive year—is projected to firm to 5.9 percent in 2025 from 5.7 percent last year, driven by higher oil output in Kazakhstan, stronger remittances, and higher public and private investment spending.
Private consumption remains the main driver of growth in ECA, although its pace is moderating as real wage gains ease and job creation slows. Strong credit growth—especially in Central Asia, the South Caucasus, the Western Balkans, and Türkiye—continues to sustain household demand. In many countries, investment has propped up growth, supported by public infrastructure and defense spending and increased inflows of foreign direct investment. Exports are recovering modestly, with global trade policy uncertainty affecting supply chains and weighing on auto suppliers in Central Europe and the Western Balkans.
Higher food prices have pushed up inflation. Median annual inflation rose to 4.9 percent by August from 3.8 percent a year ago. Hikes in administered prices also contributed. Fiscal consolidations across ECA have mostly been delayed. In more than half of the countries, fiscal deficits are set to rise this year due to higher public investment, interest costs, social spending, and defense outlays.
Growth in ECA is expected to pick up only modestly to 2.6 percent on average in 2026–27. In Russia, growth is likely to weaken further to 0.8 percent next year before picking up slightly to 1 percent in 2027. In contrast, economic expansion in Türkiye is expected to continue gaining momentum, with growth reaching 4.4 percent in 2027. Private consumption, supported by wages, remittances, and social transfers; continued infrastructure spending; and a gradual recovery in trade outside Russia are likely to sustain growth across the region. Nonetheless, there are substantial downside risks. Slow progress in advancing structural reforms has limited the scope for productivity growth to rebound and convergence to high income status to accelerate. Trade and geopolitical tensions and persistent inflation pressures have also heightened the region’s vulnerabilities.
Weakening reform momentum and slowing productivity growth resulted in positive but modest job creation in the ECA region after the 2008 Global Financial Crisis. Developments since then have contrasted with the remarkable gains across the region in the late 1990s and early 2000s, reflecting the start of the transition from planned to market economies and deeper integration into the global economy. Since then, job creation in ECA has been faster than population growth but smaller than in other developing regions with much larger increases in population. The number of people employed in ECA grew by 12 percent between 2009 and 2024. That exceeded the 7 percent increase in the region’s population, even with the substantial migration many countries experienced. Jobs growth has been driven largely by higher participation rates and a shift away from agriculture into services, which now account for over half of all jobs. Many of the new service jobs have been in low- skill occupations, even as employment in information technology and other global innovator services in the region also increased.
Rising labor force participation is a welcome development that has supported employment growth in many parts of ECA, especially Türkiye and the Western Balkans. Higher labor force participation—especially by women—accounted for just under one-half of gross job creation in ECA between 2010 and 2023. This is remarkable given that labor force participation rates in many ECA countries are already among the highest in the world. Nevertheless, significant underutilization persists among specific groups, with female and youth labor force participation rates in the region well below the levels observed in high-income European countries. A substantial portion of the region’s underutilized labor resources could be mobilized to mitigate the effects of a declining working-age population.
Young and dynamic firms, together with very large firms, generate almost all the net job creation in ECA. Startups and young small and medium-sized enterprises account for 14 percent of total employment in ECA but almost 40 percent of gross jobs created. Large businesses also contribute substantially to net job creation. By contrast, mature small and medium-sized enterprises tend to eliminate more jobs than they create.
In contrast to high-income economies, despite substantial changes in the global and regional economic environment, job responsiveness to productivity growth in ECA has remained stable over the past decade. On average, a 1 percent increase in productivity translated into a 0.15 percent increase in employment in the region over five years. Therefore, strong productivity growth is essential for job creation.
Unless resolved, structural impediments will limit the region’s productivity growth and jobs potential. Several persistent obstacles exist: an abundance of small firms that rarely scale up; subdued competition; high barriers to entry and exit; underdeveloped credit; inefficient allocation of capital and talent; outdated education and training systems, resulting in skills mismatches; and underinvestment in lifelong learning. State-owned enterprises often distort the competition environment, and they create half as many jobs and eliminate twice as many jobs, compared to private firms.
Demographic headwinds—including aging and low fertility rates—also threaten labor market resilience. Fertility is below replacement in most of the region, and the working-age population is projected to fall by about 17 million by 2050. Unlike the rest of the region, however, Central Asia and Türkiye will see significant increases in the working-age population, creating the need for more jobs.
Turning resilience into stronger growth in productivity and jobs requires bold reforms. Part II of this update is structured around three pillars of the jobs challenge that policy makers in the region need to consider to strengthen the link between economic growth and employment, reduce distortions, unlock the region’s underutilized labor potential, and help manage complex labor market transitions.
First, they need to create the infrastructure foundations for jobs, including health care, education, skills training, transportation, and energy. These investments support inclusive labor market participation and productivity and are essential to mobilize underutilized labor, increase female and youth participation rates, and support the structural transformation needed for convergence to high-income status.
Second, strengthening governance and business-enabling policies is essential to ensure a predictable regulatory environment, simplify taxes, and deepen trade and competition. Reforms of state-owned enterprises should prioritize performance, governance, and a level playing field while supporting affected workers. Deeper trade integration will enable firms to join dynamic value chains and increase their returns on innovation.
Third, mobilizing private capital is critical for investments that can drive sustainable job creation. Countries stand to gain from promoting policies to support businesses through financing, equity investments, guarantees, and political risk insurance. These policies include co-investment programs, public-private partnerships, and support to local financial intermediaries. Such policies not only bring in much-needed private capital to strategic sectors but can also expand access to risk capital.
Sectoral priorities must complement structural reforms. To translate these pillars into tangible employment gains, countries should orient sectoral policy toward five priority areas. Agribusiness can support rural development and absorb informal labor. Value-added manufacturing can anchor tradable employment and raise productivity. Tourism offers opportunities to engage youth and catalyze service ecosystems. Health care expands higher-skilled employment. Energy and infrastructure underpin competitiveness and green growth.
The region’s heterogeneity implies that countries cannot follow a single approach. For instance, compared to the rest of the region, the demographic pressures are different in Central Asia and Türkiye, where increasing the number of jobs employing the growing young population is an urgent priority. In the Western Balkans or Central Europe, in a context of a shrinking workforce, it will be crucial to upgrade jobs in terms of quality and productivity. Success will depend on country ownership, tailored approaches, and leveraging assets such as human talent and natural resources.
Central Asia’s sectoral growth is likely to be driven by expanding agri-food and livestock processing. The region will also benefit from developing transport and logistics along Eurasian corridors, investing in renewable energy, and targeting specific manufacturing niches. In addition, the tourism industry can leverage Central Asia’s exceptional heritage sites and rich cultural assets.
Across Central Europe, the most promising dynamic opportunities center on manufacturing and energy value chains, modern tradable services, and support for the aging population. These countries have strong potential in green manufacturing and energy, as well as a broad range of offshore business services, including software development, business process outsourcing, accounting, and architectural and engineering services.
Türkiye’s biggest opportunities for growth and job creation lie in tradable services and logistics, upgrading global value chain–linked manufacturing, renewable energy, care services that increase female participation, and digital and information and communications technology–enabled services.
Ukraine’s economy is undergoing a significant transformation, with the emergence of new sectors and productivity upgrades in existing industries likely to contribute to job creation. Information technology and digital industries, along with agriculture and agroprocessing, have emerged as Ukraine’s main comparative advantages. In addition, defense and associated industries have the potential to generate employment opportunities for skilled workers.
The Western Balkans presents robust opportunities for agribusiness and food processing, tourism diversification and upgrading, targeted light manufacturing (notably automotive parts), and care services.
The South Caucasus stands out for opportunities in renewable energy and exportable digital business services. The South Caucasus’s position on the Middle Corridor also creates a platform for growth in regional transport and logistics services.
Across the remainder of ECA, sectoral growth is expected to be driven by deeper integration with the European Union, modernization of financial intermediation, advancement in high-value agriculture, and expansion of digital service offshoring.
Read full report here.
 
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Today the College of Commissioners approved our Pact for the Mediterranean. For millennia, the Mediterranean has been a bridge between continents. For people, goods and ideas. These exchanges have shaped who we are and how we live. The truth is that Europe and the Mediterranean cannot exist without each other. And today, the future of our two shores is more connected than ever before. In an increasingly competitive and contested global economy, our economic ties with our Southern neighbours have already grown stronger.
Trade between the European Union and the rest of Mediterranean has increased by over 60% in just 5 years. Our value chains are more and more interconnected. So, the time is ripe for deeper integration. We should simplify making business between us. We should create new ties between our industries, our universities, our institutions. This is why today we are making a clear offer to our neighbours. Let us create a Common Mediterranean Space, with the goal of progressive integration between us. This is the essence of the Pact for the Mediterranean.
The Pact is the result of almost a year of dialogue and intense engagement with our neighbours. It is a Pact between partners. It focuses on three main pillars. The first pillar – the heart of our work – is people. The second is the economy. And the third is the link between security, preparedness and migration. For each pillar, we have identified initiatives that will deliver real change on the ground – more than 100 concrete ideas and actions. From creating a Mediterranean University, to connecting our cultural institutions and civil societies. From building AI factories across the Mediterranean, to a new initiative for Mediterranean start-ups. From managing migration together, to the new European Firefighting Hub in Cyprus. And the list is much longer. The focus is on getting things done. These initiatives will form an action plan, to be agreed with our 10 Southern neighbours. Because, to quote a proverb that is shared across the region: “Actions speak louder than words”.
On the European side, we will mobilise our financial instruments in a Team Europe approach. And crucially, we will leave no stone unturned to mobilise private investments. We also want to step up triangular cooperation, in particular with Gulf countries. Working with them is essential on projects like the India-Middle East-Europe Corridor.
This is a very special moment for the Mediterranean but also for Europe as both share a common future of peace and cooperation often during unimaginable pain and loss. The devastating war in Gaza has finally come to an end marking a pivotal moment not only for Gaza but also for the European Union and the wider Mediterranean marking the moment when future of the region is being rewritten. Europe has a stake in shaping a future of peace and prosperity. Because this is our common region. And we want to play our part as partners. It is our commitment to our shared Mediterranean home.
Thank you.
 
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Without timely and consistent implementation, we undermine the resilience of the financial system, leaving it vulnerable to future shocks

This letter was submitted to G20 Finance Ministers and Central Bank Governors (FMCBG) ahead of the G20’s meeting on 15-16 October 2025.
Andrew Bailey underscores the importance of cooperation and multilateral institutions to address the pressures from the challenging global environment.
Amid elevated risks and uncertainty, Mr Bailey highlights the need for implementing global standards and remaining vigilant to emerging threats. To facilitate this, the FSB will enhance its surveillance of vulnerabilities in the financial system, while shifting its focus from policy development to monitoring and facilitating the implementation of agreed reforms.
The letter introduces the reports that the FSB is delivering to the G20, namely:
• G20 Roadmap for Cross-border Payments: Consolidated progress report for 2025
• Monitoring Adoption of Artificial Intelligence and Related Vulnerabilities in the Financial Sector 
• G20 Implementation Monitoring Review Interim Report, delivered today with the Chair’s letter
• A thematic review, monitoring progress implementing the FSB Global Regulatory Framework for Crypto-asset Activities (to be published on 16 October).
Read full text here.

 
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By: Tobias Adrian
Policymakers should strengthen oversight of nonbank financial intermediaries, whose increasing interconnectedness with banks could exacerbate adverse shocks
Stretched asset valuations and pressures in core sovereign bond markets are keeping financial stability risks elevated amid heightened economic uncertainty. These vulnerabilities could be amplified by the growth of nonbank financial institutions—through their growing importance as market makers, liquidity providers and intermediaries in private credit, real estate, and crypto markets.
As we detail in our new Global Financial Stability Report, stress testing shows that the vulnerabilities of these nonbank intermediaries can quickly transmit to the core banking system, amplifying shocks, and complicating crisis management.
To be clear, policymakers have had nonbanks on their radar for some time. They include insurance companies, pension funds, and investment funds; and while they do not take deposits, they play an increasingly large role in global markets. Regulatory treatment also varies considerably, with dedicated supervisory frameworks for insurance companies and less comprehensive prudential oversight for many others.
While nonbanks can help facilitate capital market activities and channel credit to borrowers, their expansion also increases risk-taking and interconnectedness in the financial system. Together, nonbanks now hold around half of the world’s financial assets. In the United States and the euro area, many banks now have nonbank exposures that exceed their Tier 1 capital—a crucial cushion that allows a bank to absorb losses and remain stable in times of crisis. Similarly, nonbanks now account for half of daily foreign exchange market turnover, more than double their share of 25 years earlier, as we show in an analytical chapter of the GFSR.

This shift in financial intermediation calls for a more comprehensive, forward-looking approach to risk assessment. Unlike banks, nonbanks, for the most part, operate under lighter prudential regulation. In addition, many provide limited disclosure of their assets, leverage, and liquidity—making vulnerabilities and interconnections harder to detect.
Some regulators, including those in the United Kingdom and Australia, have begun integrating system-wide stress tests and scenario analysis to better understand interactions between banks and nonbanks. These efforts have revealed the need for better data, stronger domestic and cross-border coordination, and regulatory innovation to keep pace.
Nonbanks can transmit risks to the financial system through many channels, including private credit, real estate, and crypto assets, as mentioned above—all requiring policymaker attention. One channel we study in the new GFSR is the impact on banks. For several years, the IMF has applied its Global Stress Test, or GST, to assess banking sector resilience. This time, our test models a stagflationary shock—combining a recession, higher inflation, and rising yields on government debt. The stress test finds that banks holding about 18 percent of global assets would see their Common Equity Tier 1 ratios fall below 7 percent. Although the results mark an improvement from earlier assessments, these tests reveal a subset of weaker banks within the system.
To capture the growing interlinkages between banks and nonbanks, we introduced a new layer of analysis to our stress testing, focused on spillover risks. The results are striking: adverse developments in nonbanks—such as downgrades by credit rating agencies or falling collateral values—could significantly affect banks’ capital and liquidity ratios.
In a stress scenario in which nonbanks become riskier and fully draw their credit lines from banks, about 10 percent of US banks and 30 percent of European banks (by assets) would see their regulatory capital ratios fall by more than 100 basis points. In other words, bank losses and capital declines increase sharply alongside stress among nonbanks, demonstrating that vulnerabilities in the nonbank sector are interconnected—they can quickly transmit to the core banking system, amplifying shocks and complicating crisis management.

Another channel through which nonbanks can amplify stress in the financial system is through core bond markets—high-quality, investment-grade fixed-income securities that serve as benchmarks for the broader market. One way this can occur is via liquidity mismatches in open-ended investment funds, which arise when investors can sell shares quickly but the assets needed to meet redemptions take more time to sell. When market volatility spikes, investor redemptions and margin calls can force these funds to sell their most liquid assets.
The GFSR’s analysis of US mutual funds shows that, assuming outflow patterns similar to March 2020 and an 80-basis-point increase in interest rates, forced bond sales could reach nearly $200 billion—three-quarters of which would be Treasury securities. In extreme cases, sales could overwhelm dealer intermediation capacity, disrupt market functioning, and spill over into funding markets. These results underscore the importance of ensuring that mutual funds have adequate liquidity management tools to help reduce the risk of forced sales.
Greater nonbank involvement in sovereign bond markets does have positive effects, as we show in another analytical chapter of the GFSR. Emerging market economies with stronger fundamentals have increased their local-currency borrowings from domestic nonbanks, such as pension funds and insurance companies. The rising share of bonds held by nonbanks in emerging economies has coincided with improved liquidity when bond markets face global shocks and has likely reduced government reliance on bank borrowing.
But it’s also important to distinguish between domestic and foreign nonbanks. Foreign institutions remain key investors in emerging market assets. These investments could be withdrawn when markets become turbulent, tightening emerging market financial conditions. That means the cross-border impact of nonbanks needs to be better understood.
Policy priorities
Financial stability ultimately depends on sound policies and resilient institutions. Prudent fiscal and monetary policies, limits on external imbalances—such as current account deficits and external debt, and effective lender-of-last-resort and emergency liquidity assistance remain essential. At the same time, amid the growing prominence of nonbanks, policymakers must reinforce the resilience of the core of the financial system.
Our GST’s finding—that many banks remain vulnerable—underscores the need to further strengthen capital and liquidity by implementing internationally agreed standards, notably Basel III. Safeguarding the banking sector against contagion from weak banks can be achieved by advancing recovery and resolution frameworks and enhancing central banks’ emergency liquidity assistance.
The growing importance of nonbanks, and their links with banks, also calls for enhanced supervision. This means collecting more comprehensive data, improving forward-looking analysis—such as system-wide liquidity examinations—and strengthening coordination among sector supervisors.
Private credit certainly warrants closer attention. Nonbank lenders, especially private credit funds, have grown rapidly in recent years, adding to financial stability risks because they are less transparent and not as firmly regulated. Finally, to address liquidity pressures and forced bond sales by nonbanks, it is essential to improve and expand the availability and usability of liquidity management tools for open-ended investment funds.
—This blog is based on Chapter 1 of the October 2025 Global Financial Stability Report, “Shifting Ground Beneath the Calm: Stability Challenges amid Changes in Financial Markets.” For more, see the recent explainer blog: Five Megatrends Shaping the Rise of Nonbank Finance.
 
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Eurogroup President and Minister for Finance of Ireland, Paschal Donohoe, will represent the euro area at the Annual Meetings of the IMF and World Bank Group in Washington, DC, this week.
As President of the Eurogroup, Minister Donohoe will participate in the G7 Finance Ministers and Central Bank Governors’ meeting as well as in a range of IMF meetings. The Annual Meetings provide an opportunity for Finance Ministers and Central Bank Governors from around the world along with leading figures from the IMF and World Bank to meet and discuss global economic and development challenges, including the IMF’s assessment of the global economic outlook. The Eurogroup President will also participate in a series of media engagements to highlight the European economic and financial policy agenda.

The IMF and World Bank Group celebrated their 80-year anniversary last year, and now, maybe more than any time in recent memory, they are needed to help address the global challenges that we face. Multilateralism, particularly in the face of persistent and ongoing global conflicts and recent economic turbulence, is key for securing effective and resilient outcomes. During my visit, I look forward to a series of constructive engagements with Ministerial colleagues and officials at the IMF and the World Bank on how best to address these economic challenges and further our shared goals.
For more information, please contact:
• Kornelia Kozovska, Spokesperson for the Eurogroup President

 
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By: Pierre-Olivier Gourinchas
Dialing down uncertainty, reducing vulnerabilities, and investing in innovation can help deliver durable economic gains
In April, the United States shook global trade norms by announcing sweeping tariffs. Given the complexity and fluidity of the moment, our April report offered a range of estimates for the growth downgrade, from modest to significant, depending on the ultimate severity of the trade shock.
Six months on, where are we? The good news is that the growth downgrade is at the modest end of the range. The reasons are clear. The United States negotiated trade deals with various countries and provided multiple exemptions. Most countries refrained from retaliation, keeping instead the trading system largely open. The private sector also proved agile, front-loading imports and speedily re-routing supply chains.
As a result, the increase in tariffs and its effect has been smaller than expected so far. We now project global growth at 3.2 percent this year and 3.1 percent next year, a cumulative downgrade of 0.2 percentage point since our forecast a year earlier.

Should we conclude that the shock triggered by the tariff surge had no effect on global growth? That would be both premature and incorrect.
Premature because the US statutory effective tariff rate remains high and trade tensions continue to flare up with no guarantee yet on lasting trade agreements. Past experience suggests that it may take a long time before the full picture emerges. So far, the incidence of the tariffs seems to fall squarely on US importers, with import prices (excluding tariffs) mostly unchanged, and limited retail price increases. But they may still pass costs onto US consumers, as some have started to do, and trade may reroute permanently, leading to global efficiency losses.
Incorrect because other economic forces besides trade policy are simultaneously at play. In the United States, tighter immigration policies are shrinking the foreign-born labor supply—another negative supply shock on top of that from tariffs. So far, this has been offset by cooling labor demand, keeping unemployment steady. Financial conditions remain loose, the dollar has softened in the first half of the year, and AI-driven investment is booming. These demand-side forces are supporting activity, while adding further to the price pressures from the negative supply shocks.
In tariff-hit economies, other dynamics are helping to cushion the blow. China is weathering higher tariffs with a weaker real exchange rate, redirected exports to Asia and Europe, and fiscal support. Germany’s fiscal expansion is lifting euro area growth. Emerging market and developing economies benefitted from easier global financial conditions thanks in part to the depreciation of the US dollar, and they continue to demonstrate strong resilience reflecting in part hard-earned gains from stronger policy frameworks.
Still, despite multiple offsetting drivers, the tariff shock is further dimming already lackluster growth prospects. We expect a slowdown in the second half of this year, with only a partial recovery in 2026, and, compared to last October’s projections, inflation is expected to be persistently higher. Even in the United States, growth is weaker and inflation higher than we projected last year—hallmarks of a negative supply shock.

Overall, despite a steady first half, the outlook remains fragile, and risks remain tilted to the downside. The main risk is that tariffs may increase further from renewed and unresolved trade tensions, which, coupled with supply chain disruptions, could lower global output by 0.3 percent next year. Apart from this, four simmering downside risks are especially worrying:
1. The AI surge, promise or peril?
Today’s surging investment in artificial intelligence echoes the dot-com boom of the late 1990s. Optimism is fueling tech investment, lifting stock valuations, and boosting consumption via capital gains. This could push the real neutral interest rate upwards. Continued exuberance may require tighter monetary policy just as in the late 1990s.
But there is also a flip side. Markets could reprice sharply, especially if AI fails to justify lofty profit expectations. That would dent wealth and curb consumption, with adverse effects potentially reverberating through the financial system.

2. China’s structural struggles
The outlook remains worrisome in China, where the property sector is still on shaky footing four years after its property bubble burst. Financial stability risks are elevated and rising as real estate investment continues to contract, overall credit demand remains weak, and the economy teeters on the edge of a debt-deflation trap. Manufacturing exports have buoyed growth, but it is hard to see how this could last.
Even the pivot toward investment in new strategic sectors such as electric vehicles and solar panels through the use of large-scale subsidies, while boosting productivity in these sectors, may have contributed to a significant overall misallocation of resources and lackluster aggregate productivity gains. Across different countries, industrial policy can help boost production in targeted sectors but should be handled with care as it often brings significant fiscal, hidden costs, and potential spillovers.

3. Mounting fiscal pressures
Many governments, including some major advanced economies, face growing fiscal strains and have achieved only limited progress in rebuilding fiscal space. Without immediate action, slower economic growth, higher real interest rates, coupled with elevated debt and new spending needs—for defense, economic security, climate—will further tighten the fiscal vise. Low-income countries are especially vulnerable, despite efforts to improve their primary balances, as they face the prospect of significantly reduced aid flows. Many poorer countries remain scarred by the shocks of the last five years. Limited opportunities could fuel social unrest, particularly among unemployed youth.
4. Institutional credibility at risk
As fiscal constraints become more binding, many institutions face rising political pressure. For central banks, pressures to ease monetary policy, whether to support the economy at the expense of price stability, or to lower debt servicing costs, always backfire. While it may lower real interest rates in the short term, inflation and inflation expectations ultimately increase more than desirable. Trust in central banks helps anchor inflation expectations—especially amid shocks, as seen during the recent cost-of-living crisis. As independence erodes, decades of hard-won credibility will vanish, imperiling macroeconomic and financial stability.

The right policies can help
While downside risks dominate, a few important developments could quickly brighten the outlook. First, resolving policy uncertainty would provide a significant lift to the global economy. Clearer and more stable bilateral and multilateral trade agreements can raise global output by 0.4 percent in the very near term. A return to low tariffs that prevailed before January 2025 based on these agreements adds even more upside, about 0.3 percent. Second, beyond its effects on investment, AI could raise total factor productivity. Under modest assumptions, the combined effects of lower uncertainty, lower tariffs, and AI could raise global output by about 1 percent in the near term.
This underscores how policies that help restore confidence and predictability can improve our growth prospects. For trade policy, the objective should be to reduce uncertainty and set clear, transparent rules that reflect the changing nature of trade relations, looking to deepen trade ties where possible. That most countries have so far avoided retaliation and sought to forge better trade deals offers a glimmer of hope.
This needs to be paired with improved domestic policies which will also go a long way in reducing global imbalances. Where needed, fiscal policy should aim to reduce vulnerabilities. This should be done gradually and credibly, but governments must not delay further. Improving the efficiency of public spending is an important way to encourage private investment. Monetary policy should remain independent, transparent and tailored with a key objective to maintain price stability.
Beyond short-term stability, we must invest more in the future. Governments should empower private entrepreneurs to innovate and thrive. Productivity fuels sustainable growth, and the progress of AI, with the right guardrails, can help lift medium-term prospects. While sectoral industrial policies are increasingly tempting policymakers, policies to support education, public research, infrastructure, governance, financial stability, and smart regulation that balances innovation with risk management offer a better and less costly path.
A pragmatic and adaptive multilateral system that fosters cooperation can help us meet these challenges.
—This blog is based on Chapter 1 of the October 2025 World Economic Outlook, “Global Economy in Flux, Prospects Remain Dim.”
 
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By: Era Dabla-Norris, Davide Furceri, Zsuzsa Munkacsi, Galen Sher
Spending more efficiently and reallocating public funds toward investment and innovation can be a powerful growth strategy
Over the past two decades, Rwanda achieved remarkable progress. Nearly every household now has access to mobile phones and primary education. More than half the population has electricity, and one in five has clean drinking water and sanitation services. Rwandans consume three times more electricity and live 20 years longer.
These gains came from relatively modest increases in investment, education, and health spending from $150 to $420 per person—which is even below the sub-Saharan African average. What made the difference in Rwanda was more efficient public spending. This approach is an answer to fiscal pressures stemming from slow growth, rising debt, aging populations, and growing demands for defense. The key is to make every penny of taxpayer resources count.
Our new analysis of 174 economies in the latest Fiscal Monitor shows that governments could gain one-third more value from their spending, on average, by adopting best practices. By spending more efficiently and better allocating existing resources, emerging markets and developing economies can increase output by 11 percent, and advanced economies by 4 percent, over the long term. Spending smarter is more than a fiscal tactic—it’s a growth strategy.

What spending smarter means
First, it means allocating existing spending better. In most countries, public investment, which can be growth-enhancing, has declined by 2 percentage points of total expenditure over the past two decades. Another such area is education, where public spending has remained modest at about 11 percent of total spending. At the same time, many countries are faced with high public wage bills, which account on average for a quarter of total expenditure.
Second, it means improving the “technical efficiency of spending”—the maximum achievable output given a fixed level of public expenditure. To measure this, we compare observed outcomes to best-practice management, technology, and institutional arrangements. For example, Canada spends about $2,500 per person annually on education—roughly $300 less than other advanced economies. Yet adults complete an average of 13.7 years of schooling, making Canada the second best in the world, behind Germany.
Significant economic gains
Smart public spending can substantially boost long-term growth in both advanced and developing economies.
Our analysis shows that shifting 1 percent of gross domestic product from lower‑impact government consumption into infrastructure investment raises output by about 1.5 percent in advanced economies and 3.5 percent in emerging market and developing economies over about 25 years. Redirecting the same amount toward human capital investment, for example by upgrading education systems, can yield around 3 to 6 percent, respectively, in those two country groups. Importantly, this reallocation of spending can also reduce income inequality.
Spending more efficiently amplifies these long-term gains. Improving investment efficiency by 10 percentage points can further boost output gains by 1.4 percent. The faster countries close these gaps, the greater and quicker the payoffs.
Complementary policies also matter. In advanced economies, pairing research and development with human capital investment enhances productivity. In emerging and developing economies, combining infrastructure spending with education spending balances near‑term and longer‑term gains: physical capital boosts output quickly, while human capital builds future productivity.

Making reforms work
Spending reforms are challenging. Countries often establish minimum legal levels of funding for education, health, and social protection. Public salaries and pensions are also hard to change. Globally, about one-third of spending is effectively “locked in,” with advanced economies facing the highest rigidity.
But there are good examples of how to move forward. Estonia and Sweden reduced rigidity by actively using multiyear fiscal planning, which requires new spending to be offset in future years. They also linked budget allocations more closely to past performance. This strategic approach to spending reforms is more effective than across-the-board cuts, which can disrupt essential services and reduce efficiency.
Combating corruption, strengthening the rule of law, and increasing budget transparency could also increase efficiency. Competitive procurement processes, improved management of public investment, and digitalization of public finances help too. Togo, for example, increased its investment efficiency by 5 percentage points after introducing cost-benefit analyses for all projects and multiyear planning in 2016.
Linking retirement ages to life expectancy, or emphasizing disease prevention to curb future health costs, can secure long-term sustainability of social spending. Aligning public compensation with market benchmarks and strengthening payroll controls are also key—especially in developing economies where public sector wages often exceed private sector ones by 10 percent or more.
Finally, spending reviews with clear objectives and links to budget decisions help governments identify savings and increase impact. In the Slovak Republic, such reviews uncovered potential savings of 7 percent of public expenditure.
The bottom line is this: by stepping up spending efficiency and better channeling existing resources, countries can strengthen public finances, build resilience, and increase their long-term economic growth.
 
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