I was asked by a couple of news agencies yesterday what I thought of the new winter economic forecast from the European Commission.
I am neither an optimist nor a pessimist. Average EU growth is picking up but the stark reality is that many economies in Europe will be weighed down for several years to come, with anaemic growth, a deflationary economy, and strong pressures to get better control of fiscal policy and the size of the public debt. It will be worse than a lost decade; the time it will take for many of the problem economies to correct past mistakes and behaviour will extend beyond a decade. Under a positive, steady-state like scenario, countries like France and Spain will have brought down fiscal deficits to zero by 2020.
But general figures for the EU or the Eurozone also hide the fact that some economies will perform better. Several Nordic economies, especially the Baltics, will have healthy growth levels in the next few years. German economic growth will not exactly be staggering, but it will be better than many of its Eurozone peers and it will help to raise the EU’s general growth. Deficits and debts are under control in Germany, and unemployment is low. The weak points are the crisis economies that will have to go through much more fiscal consolidation to bring down their deficits – and that will happen at a time when there is no strong recovery that help to bring about stronger fiscal positions. Italy, Greece, France and Spain will remain in weak economic positions, and we are not seeing many indications that national politicians are planning for new economic policies that would help them to grow. They are all in need of new and, with the current economic jargon, expansionary monetary conditions to avoid prolonged disinflation or outright deflation. The room for fiscal expansion is close to zero.
We have to admit, though, that a monetary jolt is not going to have the same effect today as if the ECB had done the right thing, say, three years ago. Unorthodox monetary policy is clearly needed to raise inflation, but a short-term monetary fix is unlikely to have lasting effects given the ECB’s culture and its constitutional limits. Give the current institutional conditions the likely scenario in the next few years is that the asymmetric rule apply: it reacts if inflation is on a path exceeding 2 percent, but it does not react if inflation is anchored well below 2 percent. Moreover, after several years of economic contraction, assets and supply factors have begun to retire and monetary (or fiscal) expansion cannot support output in the same way they could a few years ago. My conclusion is that the ECB has to changes its overall monetary policy – to a new rules-based policy substituting the defunct inflation-target policy. Absent that, ECB policy will remain unconvincing.
So the big risks are still in the financial and monetary system – and such risks, combined, with weak capacity by several governments to deal with new financial problems, like the collapse of a bank, will remain the main downside risk for some time to come. The other big risk, in the medium term, is that countries will no longer accept the quid pro quo for staying in the euro. With high unemployment, austere fiscal conditions, and lack of structural reforms and adjustments – one wonders how long the political compact for the euro will remain unchallenged by established parties?