Economists say euro crisis may not be over


A top EU economist has warned that consumption is unsustainable in parts of the eurozone and that many countries would not recover economically for "many years" – an assessment backed other experts who call for reforms at European and national levels.

"The fall in GDP will not be recouped in many countries for many, many years," said Jürgen Kröger, a section director in the European Commission's DG for economic and financial affairs and a member of the so-called Troika overseeing Portugal's recovery.

Kröger said per-capita consumption in many countries outpaces economic performance.

The gloomy forecast comes as markets have stabilised after months of turbulence over sovereign debt and fissures in the eurozone over how to respond. To add liquidity to the economy, the European Central Bank has provided some €1 trillion in low-interest three-year loans to eurozone banks in recent months.

Kröger and other analysts spoke yesterday (8 March) at a panel discussion held byEURACTIV and sponsored by German financial services firm Allianz.

The economists said there was significant uncertainty over developments in the eurozone in 2012. Allianz tentatively projects 0.3% growth for the currency area this year, one of the more optimistic estimates. The ECB yesterday projected the eurozone's GDP growth at between -0.5% and 0.3% for 2012.

Budget deficits not the only issue

Michael Heise, chief economist at Allianz, highlighted findings from his company's 2011 Euro Monitor report, which ranks countries by how economically 'balanced' they are. He said these indicators were broader than those used by the Commission's reports because Allianz did not have its "political restrictions".

Besides factors such as government debt and current account balances, the report factors in exchange rates and housing market fluctuations. Property speculation was a major contributor to the financial crisis in Spain and Ireland.

"These macroeconomic imbalances were at the heart of the crisis that has taken place in the eurozone," Heise said. "We tended to overlook these quite dangerous imbalances in the last decade, focusing mainly on the fiscal issues, which were of course the content of the Stability and Growth Pact – the famous 3% [deficit target]."

"But the fact that many countries did reach figures between zero and 3% did not safeguard them from the huge crisis that actually took place," he added, citing the Spanish and Irish cases.

EU rules mean 'economic and political suicide'

European leaders have come under fire for their approach to the fiscal and economic woes, largely focused on budget discipline despite mounting unemployment and economic stagnation.

Heise argued that the new fiscal treaty approved by EU leaders, while "a step forward" and created "swiftly", "may not be the historic event that some policymakers have described it to be."

He added that he was "sceptical" of attempts to balance budgets through sanctions alone.

Guntram Wolff, deputy director of the economic think tank Bruegel, echoed this sentiment, arguing that for many countries the necessary budget balancing was "impossible".

He cited the example of Spain, which according to EU rules would be expected to reduce its deficit by 4% of GDP this year through tax rises and spending cuts. But such measures would likely further increase the country's already high unemployment, which topped 23% overall in January and nearly 50% for young people.

"The eurozone rules ask for balanced budgets and fiscal consolidation at the national level but at the same time it means economic and political suicide for the country itself," Wolff said.

"Being a German and having read the history books a bit, I know there are stages when you don't want to increase unemployment far beyond where it is already," he said.

Wolff added it was possible the Commission give Spain a waiver from budget rules this year citing "extraordinary circumstances".

The Allianz report, however, also indicates that some of the macro-economic imbalances are being remedied, saying that 12 of 17 eurozone countries had broadly improved their positions in 2011.

Wolff, however, argued the rebalancing was taking place far too slowly, saying the pace was "very moderate compared to what we need." He said different levels of real inflation were needed in eurozone countries, with wages and prices increasing more quickly in the north while stabilising in the south.

The necessary rebalancing is not occurring fast enough given the time the ECB has bought for eurozone leaders through its lending operations.

Wolff said banks "have become completely addicted to ECB liquidity and in three years time we will have to the same discussions because the underlying fundamentals move very slowly."

Differences from the US

The panellists noted the marked differences between the eurozone and the United States were a source of difficulties.

Allianz's Heise said the US has been "over-consuming for many, many years now. It has the privilege of issuing a world-currency that is accepted by investors around the world and which finances this type of over-spending in the US." As a result, America is able to finance massive current account and public sector deficits.

The euro has been rising as a global currency since its creation in 1999 and it now makes up over 25% of international currency reserves. It is still far from dethroning the US dollar however, which accounts for 60% of international reserves.

Wolff argued that the level of budget cuts expected in depressed peripheral economies were too high given the absence of a US-style federal insurance programme to cushion the unemployed and stimulate consumption.

"How much do we add in terms of fiscal capacity at a eurozone level, a federal level, to deal with these very bad shocks in individual member states? That's the big debate that we need to have," he said.

There were also some notes of optimism for the euro. Heise argued that the cost of a eurozone breakup would be so high that politicians, including in Germany, would have to embrace shared debt through the sale of eurobonds.

European Commission President José Manuel Barroso presented the idea in November, which he and other proponents say would calm financial markets and lower the interest rates that national governments must pay to market their debt.

At a press conference yesterday (8 March), European Central Bank President Mario Draghi offered this assessment of the economic situation: "Real GDP contracted by 0.3% in the euro area in the fourth quarter of 2011. According to recent survey data, there are signs of a stabilisation in economic activity, albeit still at a low level."

He said ECB projections foresee annual real GDP growth in a range between -0.5% and 0.3% in 2012 and between 0.0% and 2.2% in 2013. "Compared with the December 2011 Eurosystem staff macroeconomic projections, the ranges have been shifted slightly downwards," he said.

Draghi noted there remained "downside risks" due to potential new tensions in euro debt markets and the rise of commodity prices, such as oil.

European leaders have struggled to balance fiscal discipline and growth over the past years. This came to head in late 2011, when the EU entered a double-dip recession and its economy shrank by 0.3% during the last quarter.

The situation has calmed following the injection of over €1 trillion in low-interest three-year loans by the European Central Bank, given to over 1,000 eurozone banks.

The interest costs for eurozone governments to refinance themselves have since fallen and German Chancellor Angela Merkel has suggested the lending will buy EU leaders time to implement reforms to increase competitiveness and growth.

However, it is uncertain whether this stabilisation will be lasting and whether the peripheral economies can bear the social costs. Eurozone unemployment rose to 10.7% last January but it is unevenly spread, with youth unemployment reaching one-in-two people in Spain and Greece.

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