At the beginning of this year, there were forecasts that Europe could pick up the economic slack created by the U.S. downturn and Japan's continuing economic problems. The 12-nation common currency, the euro, was enjoying a rise against the dollar after falling steadily in the first year of its existence. European companies were seeking acquisitions in the United States and Asia. Governments were introducing tax and structural reforms to sharpen competitiveness. After 3.4 percent growth in 2000, optimists saw 2001 as the year of Europe.

Six months later, the picture looks very different. Growth is falling across the continent. Last Thursday, the European Central Bank forecast that the euro zone's economy would expand by between 2.2 and 2.8 percent this year and by 2.1 to 3 percent in 2002. Meanwhile, inflation is rising, boosted by currency factors and high food and oil prices. This year's inflation now seems likely to be in the 2.3-2.7 percent range.

Unemployment remains high in some major European economies despite years of government programs to reduce it. Structural reforms that could upset voters are being put on the back burner as center-left governments in Germany and France face national elections next year. The euro, meanwhile, has slumped once more, restoring the dollar to its all-powerful position on world currency markets.

Britain, outside the euro zone, has been hit both by rising inflation and by the effects of the strong pound on manufacturing exports. Although Prime Minister Tony Blair is said to be keen to follow his sweeping election victory with a referendum to take the country into the euro zone, doubts are rising over how the pound can be brought down to a suitable level for membership without fueling strong inflation. And opinion polls still show strong opposition to joining the common currency.

The ECB, which sets interest rates for the euro zone, is committed to reducing inflation to 2 percent. But the trend is heading in the opposite direction. So the bank cannot cut rates on top of the reduction it implemented a month ago. But that risks increasing downward pressure on growth at a time when the U.S. slowdown has affected European exporters.

It was fortunate that the euro was established at the beginning of last year during a period of strong growth that permitted the criteria for monetary union, particularly on budget deficit levels, to be met without much difficulty. But the question now is how this criteria will fare in a harsher economic climate. The reduced growth and the resulting fall in fiscal revenue means that governments that brought in tax cuts now have a problem meeting the euro-zone criteria for lowering their deficits. Some, like France's Socialist government, have put themselves even more at risk by announcing increases in public spending. Last week, the ECB said four countries -- Germany, France, Italy and Portugal -- would not reach their deficit targets next year.

That, combined with reduced growth, would further undermine confidence just at a time when the 12-nation zone faces the major test of converting national currencies into euros next January. Several governments have warned that many companies are not properly prepared for the changeover, while consumers face the psychological challenge of using euro notes and coins instead of marks, francs and other familiar national currencies.

As officials at the ECB acknowledge, what is really needed in Europe to boost growth is more thorough structural reform, including liberalization of sectors where national barriers still stand in the way of the full achievement of the EU's single market. But that means governments coming to grips with the cost of Europe's popular welfare systems and dismantling job-protection regulations, which businesses say cramps growth. On the contrary, however, signs indicate that major governments are not going to embark on politically tricky reforms during the upcoming election period.

The prospect, therefore, is for continuing weakness of the euro, which American bank analysts in particular appear to view as a currency to steer clear of, especially if the upward trend in inflation continues. That risks becoming a self-fulfilling prophecy as the euro's weakness sends the price of dollar-denominated imports upward, thus further fueling inflation.

The natural inclination of politicians, particularly those facing elections in 2002, may be to try to fudge the thorny issues that confront them. But the need for Europe both to confront its challenges and to lay the groundwork for renewed growth next year is clear. The economic test is big enough, but major political will is also needed if Europe is to play its full role in the world with confidence.