Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday 6 May 2016

The Eurozone recovery

Which posted the strongest growth at the beginning of 2016: the US, UK or the Eurozone? The answer is the Eurozone. Growth at 0.6% for the quarter (about 2.5% at an annual rate) is nothing to write home about, but it is not the stuff of doom and gloom either. Reasonable growth like that should come as no surprise. The economy is receiving as much monetary stimulus as the ECB can currently muster, and fiscal contraction has come to a halt.

Inflation is still well below target, but the reason for that is straightforward enough (as Martin Sandbu points out): there is still a lot of spare capacity. Inflation will only stabilise at around the 2% target when that spare capacity has disappeared. Policy should be doing everything (more public investment!) to ensure that happens through strong growth rather than, as seems to have happened in the UK, a gradual contraction in supply. On inflation the ECB should make their target 2%, rather than the current ‘below but close to’ 2%, to avoid the Japan problem that Narayana Kocherlakota discusses here.

I went further when I wrote two weeks ago (the GDP figures came out a week ago) that “I also think we may see rapid Eurozone growth before [2020]”. By rapid growth I mean something in excess of 2.5%. I said that because I was adding one other factor into the mix of fiscal neutrality and monetary expansion, which is that the Euro has been pretty competitive for well over a year. As Martin points out, that has so far not contributed anything to recent Eurozone growth.

I have read in a few places recently people saying that the impact of international competitiveness is not what it was. I agree with Paul Krugman that this pessimism is unlikely to be warranted. I have spent a significant part of my working life estimating and applying trade elasticities (the impact of international competitiveness on trade and hence demand), and this experience has taught me that this effect is a bit like Milton Friedman’s description of how monetary policy works: there can be long and variable lags. So I expect that the Eurozone’s competitiveness gain over the last year and a half will begin to impact on Eurozone GDP at some point in the next year or two, and that might just provide more rapid growth than we saw at the beginning of 2016.


  1. 'International competitiveness' should be perhaps called out for what it is – importing demand and indirectly suppressing domestic demand in the source countries so they will export it even more.

    In fact it should perhaps be called what it is *stealing* demand from source countries because they ideologically refuse to create any of their own. It should perhaps be called out as morally wrong and dangerous – particularly in the Eurozone.

    It’s quite interesting that stealing demand is considered virtuous, much as reducing government deficits is seen as virtuous. Even though both behaviours are destructive.

  2. I've asked this before but didn't get an answer. Let me try it again.

    I'm not an economist so maybe I'm missing something but I'd like to understand what you think about this. Isn't the 2% target likely to be insufficiently high to unjam the markets of large parts of the Europe?

    What if, the real safe return on new capital, on marginal net investment in large parts of Greece, Italy and Spain, for example, is below -2%.

    There is nothing that says that market rates couldn't be bellow -2%. Isn't 2% inflation forcing an economy wide subsidy to savers that pull money out of economic activity and store it as idle money?

    Sure government spending could help this situation but what if it brings inflation up to 2% while the European economy is still far from full output? Won't the central bank tighten, negate the benefits of any additional fiscal stimulation and leave everyone with little to show for their new debt?

    1. " Isn't 2% inflation forcing an economy wide subsidy to savers that pull money out of economic activity and store it as idle money?"

      AFAICT, no, as what you ascribe to inflation is in fact due to deflation. I rather think that as long as there is unemployment, inflation is desirable, probably a 4 % would be even better than a 2 %.

    2. Antoni, that is what I am saying. 2% inflation may not be enough to unjam the investment and labor markets any time soon and government fiscal stimulation may help but this help might be severely hindered if central banks start tightening in response (which in the case of the ECB, it has a history of doing).

      It seems to me that it is important to fix the monetary policy before doing the government fiscal stimulation as to allow for this stimulation to work.

      On top of that, there is an expectation component to all this. If banks, businesses and governments suspect that the ECB will tighten if they borrow or invest, they will not borrow and invest, a vicious circle that will keep the multiplier and inflation low.

      On top of this top, as a large, liquid and easily exchangeable currency, the euro will not only jam the eurozone labor markets, it can suck investment from outside. Businesses and banks in the UK for example, can invest and hire people or they can just buy euros and hold on to them and reap above market real returns.

      Currencies that retain value too much are a subsidy to economic destruction. The UK is probably more affected by grave ECB mismanagement than by the moves of its own central bank.

      I live in a rural province of Canada with above 10% unemployment. I fully blame the large insufficiently inflationary currencies of the world to suck investment out of here and cause general poverty and misery, even if the Bank of Canada has done a comparatively good job at monetary policy.

      The mere existence of large internationally tradable currencies can mean new capital investment cannot reach rural and disadvantaged areas if these currencies retain real value at above market marginal investment returns for these regions. We saw how emerging markets crashed when the Fed signaled it would do its first rate increase.

      As a small province of Canada, our main economic determinants may well be the ECB and the Fed and we have no control over them. What can we do to protect ourselves from the economic war the ECB seems to be waging against the world?

      The only thing I can think of would be to setup capital controls so that at least the money of savers in the province would be reinvested in our province. This is probably illegal on multiple levels.

      I'm all for free trade but it looks like it may not be a good deal when you throw in a destructive currency like the Euro into the mix.

      Maybe the UK, Canada and other countries that trade with the eurozone could setup a capital control perimeter just around the eurozone to prevent investment money from being sucked into idle euros until the ECB figures its shit out.

      Around here, talks of risks that our government defaults have become perennial. Our health care system is crumbling which means unnecessary deaths. We cannot wait much longer. Desperate times call for desperate measures.


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