What Could Hamper the Recovery and the Return of Confidence

THE EUROZONE IS GROWING, BUT ITS RECOVERY COULD BE UNDERMINED BY A RASH POLITICAL CHOICE FORCING THE ECB TO ABANDON QUANTITATIVE EASING

by Francesco Daveri, SDA Bocconi School of Management
Translated by Alex Foti

After the euro crisis breaking in the summer of 2011, for a few years Europe became a problem for the world economy, due to its dismal growth performance and risk of macroeconomic instability. In 2012, while the rest of the world grew by 4.4 per cent, the eurozone contracted by nearly one per cent. And the economic crisis was particularly insidious because it caught the monetary union unprepared, since it lacked, and it still does, Europe-wide emergency intervention tools, and more in general, didn't have a system for monitoring and managing government budgets capable of dealing with serious shocks such as those experienced in the summer of 2011 or in 2008-09.
 
➜ Businesses and households are hopeful about the future
Six years after that terrible summer, the sky seems to have partly cleared. Europe, in particular the eurozone, is no longer a source of concern but, conversely, starts to be seen by investors and residents alike as an actor capable of contributing to solving the problems of the world economy. There is a return to positive economic growth, with business recovery lasting 17 consecutive quarters now, which has become stronger in recent months and is now stably above 2 percent on an annual basis.

The recovery also affected the labor market, bringing  a sharp reduction in the numbers of the unemployed (26.5 million in mid 2013, less than 15 million in mid-2017), so that the unemployment rate is now at 9 percent, after reaching 13 percent at the peak of the crisis. And growth is driving a recovery in consumption, as retail sales increased by 6 percent in value terms and 8 percent in terms of volume with respect to the first half of 2013. Consumption growth has also led to a partial recovery of industrial production, with a 5 percent gain with respect to the trough of early 2013. With the return of growth, also the confidence of families and businesses in their economic future grows, coupled with a better outlook for the countries in which they are part. And this is the case in the economices worst afftected by the crisis, countries like Italy, Portugal and Greece. The return of confidence is not only positive for social cohesion, but it also makes it easier for people to buy a home or a car, or for young couples to start a family. In short, the return of confidence contributes to making the recovery more sustainable.
 
➜ Germany's role
However, it is equally clear that much remains to be done to strengthen the progress made so far. Thanks to the recovery, by mid-2015, the GDP of the eurozone had already climbed back to where it was before the financial crisis. However, at 9 percent, unemployment remains above pre-crisis levels, especially for younger generations. The recovery of industrial production has had a positive effect in terms of re-shoring of some manufacturing activities, but this process has only affected certain industries (especially those producing non-durable goods and automotive goods) while energy products and durable consumer goods other than the automotive are far from pre-crisis production levels, which will probably never be attained again. No recovery, no matter how persistent, can in fact offset the long-lasting effects of the offshoring of manufacturing toward Asian economies (characterized by low production costs and favorable demographic trends) over the last 20 years.

But it is politics that poses main threat to the continuation of European recovery. More than electoral outcomes (after Germany at the end of September 2017, Italy will vote in 2018), what's worrying is that the ECB could prematurely or disorderly end the policy of buying government securities. If this were to happen, Europe would be left without the only kind of macroeconomic policy that managed to restore confidence and show that the Single Currency is more than simply a set of fiscal thresholds that should not be trespassed.

The reasons for a quick conclusion to quantitative easing are coming from the unmotivated and myopic instincts of the German electorate and Germany's High Court. For the continuation of the recovery, it is only to be hoped that the geopolitical tensions of these months and the sudden appreciation of the euro will soften Germany's stance, preserving the consensus needed for the continuation of the calibrated and determined monetary policy implemented by Frankfurt so far.

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