NEW YORK (CNNMoney.com) -- The European economy will continue its tenuous recovery this year and next, but European Union policymakers need to address some long-standing problems to ensure fiscal discipline going forward, the International Monetary Fund said Tuesday.
In its May outlook for the European economy, the IMF said economic activity in the region will pick up in 2010 and 2011 from depressed levels due to stronger exports and the impact of government stimulus measures. But the pace of growth will be weak: Unemployment is expected to rise, and ongoing problems in the banking sector continue to weigh on credit.
The prospect of an uneven recovery presents a difficult problem for European leaders. They're already struggling to contain a growing fiscal meltdown, calm jittery financial markets and ensure the long-term viability of the 16-nation monetary union.
"People are worried about fiscal sustainability in a number of countries," said Luc Everaert, assistant director of the IMF's European department. "Policymakers will have to tread a fine line between balancing support for the economy, making sure to repair the financial system in time and demonstrating that all of their policies are actually sustainable."
The forecast comes days after European officials approved a nearly $1 trillion rescue plan to contain the debt crisis in troubled member nations and stabilize the euro. The plan, which includes a $284 billion (250 billion euros) contribution from the IMF, was hammered out over the weekend to avert a growing market panic. Investors cheered the plan's size and scope Monday, with stocks rallying around the world.
The rescue plan, made up largely of government backed loans, is designed to put the weight of Germany and France, the strongest economies in the European Union, behind weaker members such as Greece, Portugal and Spain.
Greece, where riots erupted last week after the government announced cuts to public spending, highlights the need for an overhaul of the EU system, according to the IMF report.
"The Greek crisis is a powerful reminder of long-standing gaps in the area's fiscal architecture," the report said. "Filling those gaps will require a substantial strengthening of fiscal discipline in good times and the introduction of procedures to manage crises."
In addition to calling for a stronger fiscal framework, the IMF report raised questions about the long-term sustainability of fiscal stimulus programs.
"The costs and limits of many crisis interventions are of growing concern," the report said, adding that "supportive" economic policies are still needed to keep the European economy on the path to recovery.
Given the risk of a double-dip recession in Europe and the massive costs involved, the report said efforts to stabilize public debt are "neither feasible nor desirable" in the short run.
But the IMF acknowledged that countries with already high debt loads will need to cut deficits this year, and that all EU countries need to take steps to shrink debt loads over the long run.
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