“Tailwinds support the recovery”, proudly stated the European Commission’s Spring 2015 Economic Forecast. Even without reading the full report, one gains a general sense of the predictions for each country just by reading the title of each chapter. For example, if you find yourself in a conversation discussing economic progress in Estonia, you can get away with saying that there is an expectation of “growth despite external constraints” while still sounding knowledgeable. However, there is a great deal more worth discussing than just the overarching titles for each country’s predictions. In fact, despite a positive outlook, the Eurozone is still pretty much in the woods.
There are several factors contributing to the spring forecast’s relatively positive report. Oil prices have dropped significantly in the last year, with an additional plunge this Thursday, which have acted like a tax cut for European consumers, boosting their spending power. Many governments throughout the region have also been able to cut down on painful austerity measures as the budget deficits in their respective countries are finally in line with the budget rules of the European Commission. Additionally, global growth is steady and there are supportive policies within the Eurozone, which should allow for further economic recovery.
This year’s previous report has now been revised upwards, with a more positive growth forecast of 1.5%. Furthermore, the Eurozone economy, composed of the 19 member nations is expected to growby 1.9% in the coming year, surpassing forecasts for the US and UK for the first time since 2011. The commission reported that domestic demand is the driving force behind this and a renewed investment drive will add to the EU’s overall GDP. Valdis Dombrovskis (EC Vice President for the Euro and Social Dialogue) has stated that nations must carry out additional structural changes, spur investment, and encourage fiscal responsibility to maintain recovery.
Thanks to the aggressive quantitative easing programme implemented by the European Central Bank earlier this year, the euro continues to lose ground against the dollar while also driving down interest rates. By purchasing billions in euro assets – essentially flooding the European economy with a greater money supply – the ECB can maintain these lower interest rates and in a sense, give consumers more freedom in domestic spending. These efforts are also expected to improve credit conditions in spite of recent Greek economic setbacks. Furthermore, the program has also helped to ease concerns over a “Grexit” because it shows that the ECB could step in if Greece does in fact abandon the Euro.
A great deal of Europe’s economic momentum is coming from Germany, the largest economy in the region. Out of the 19 central banks in the currency union, the power of a particular central bank depends on the weight of the country in the Eurozone, a process called risk-pooling via capital keys. The Bundesbank, the central bank of Germany, bears 26% of the policy burden meaning Germany is carrying out 26% of European quantitative easing from within its own borders. Considering the fact that Germany’s economy is largely driven by exports, Berlin can expect further growth as long as the ECB continues this program.
A strong job market and low interest rates are additional factors contributing to Germany’s strength. Moreover, now that the euro weakened against the currencies of the US, UK and China – the largest importers of German goods – Berlin will see further increases in exports. While this is good news for Germany, it is disconcerting for other countries in the Eurozone.
Berlin has received extensive criticism for relying too heavily on exports without implementing measures to increase domestic consumption. Germany’s account surplus will break all previous records reaching a “modern-era high” of 7.9% of GDP and is expected to fall no lower than 7.7% in 2016. This is the fifth consecutive year that Germany has gone unpunished for its excessive surplus, which violates the EU mandate that limits member nations to 6% as a creditor nation. The EU’s Macroeconomic Imbalance Procedure states that the commission should launch infringement proceedings after three consecutive years above the threshold.
Simon Tilford, economist at the Centre for European Reform, claims the surplus should be treated in the same way as the deficits in the southern countries were and force fiscal reform. The threat posed for the rest of the Eurozone by a spending-shy Berlin is significant since it limits the flows of cross-border trade, especially at a time when most Member States are trying to get their economies off the ground. Indeed, the US Treasury, the IMF and the EU have all called on Germany to do more to reflate the Eurozone economy. Germany can expect further pressure to implement programs to reduce this surplus in coming years.
Moreover, the main problems of the recent debt crisis in the EU, such as high unemployment and weak investment spending still weigh heavily on the Eurozone economy. Even if the European economy has climbed out of recession two years ago, the road to recovery has been marred by divergent economic policies inside the Eurozone driven by the reluctance of southern economies to increase competitiveness and the stubbornness of Berlin to accelerate domestic spending. Unlike the US, economic growth has not translated into lower unemployment rates and even if the recent Commission forecast is upbeat, the road to pre-crisis levels is still long and arduous.