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OPINION

The Economic Outlook for Europe

The Economic Outlook for Europe

As we approach the end of 2013, it’s a good time to reflect on the past year and the current state of the euro economy. Unfortunately, 2013 was another crisis year for the eurozone countries and Europe as a whole, with rising unemployment – especially regarding youth – coupled with sluggish growth. 


Recent statistics from Eurostat show that euro area (EA17) unemployment stood at 12.1% for October 2013, down 0.1% from the previous month. The lowest unemployment rates were recorded in Austria, Germany, and Luxembourg (less than 6%), and the highest in Greece and Spain (around 27%). It is worth noting that Cyprus and Greece were among the countries with the highest recent increases, while those with the largest decreases were Latvia and Ireland. 


Both Latvia and Ireland have experienced economic crises and were supported by an IFM/EU-funded programme that included very tough austerity measures. Both countries have now exited their respective programmes successfully and can borrow at low, sustainable rates from the financial markets. At the peak of their crisis, Latvia’s 10-year bond yields were at 17% (September 2009) while Ireland’d were at almost 12% (June 2011) but now both countries trade at 10-year yields of lower than 4%. Obviously the financial markets have rewarded them for the determination they have shown and for turning their economy around. The youth unemployment rate (below 25 years of age) is especially worrying – the latest statistics show that it is 24.4% for the EA17 countries while in the southern European countries (Greece and Spain) it stands at more than 57%.


If we look at GDP growth rates, they rose by merely 0.1% in the EA17 area (and 0.2% for the EU28) during the third quarter of 2013 after a period of recession. Furthermore, the overall budget deficit is -2.3% while inflation is 0.9% for November 2013. This is well below the target rate of 2% that the ECB wants to maintain in the medium term. The possibility of deflation in the near future raises some concerns. First, falling prices worsen the position of debtors since they increase the real burden of their debt. Second, this causes consumers/investors to borrow less and spend less, which does not help promote growth. It can also create a deflationary trap, where the expectation of falling prices makes people to spend less. Third, in deflationary periods wages and prices fall and that can lead to higher unemployment if workers do not accept wage cuts.  


Now, what are the underlying problems behind the euro crisis? Certainly, the loss of competitiveness to other regions of the world (US, Japan, emerging markets) is a major reason (mainly affecting the Southern European countries). Furthermore, the budget deficits experienced by a number of eurozone countries have also led to increases in public debt (making the debt in some cases unsustainable) due to uncontrolled government spending. This is even more serious when the rate of increase is faster than GDP growth. Another reason is the low birth rate coupled with increased life expectancy which translates into higher pension and health costs. Finally, the fact that there is no fiscal and banking union yet, but a monetary union that does not give the opportunity to member states to devalue their own currency to tackle problems, has exacerbated the euro crisis. 


The ECB has responded to the crisis with both conventional and unconventional monetary tools. The ECB current (base) rate has been at 25 basis points (0.25%) since last month. This is extremely low but similar to that of other central banks (US Federal Reserve, Bank of England, Bank of Japan), but is not enough. That is why the ECB has also applied unconventional monetary tools, such as the Securities Markets Programme (SMP) from 2010 to early 2012, or Outright Monetary Transactions (OMT) announced in September 2012. Through these programmes, the ECB has essentially bought government bonds from the secondary market of countries that were severely affected by the crisis (PIIGS). But even these unconventional actions have not brought the desired outcomes. Recent statements by ECB executives indicate that a large-scale asset purchase programme (similar to the QE programmes in the US, UK, and Japan) is still an option since Europe is still suffering from low growth and rising unemployment, despite the very low interest rates. 


Thus, my forecast for 2014 is that unless the ECB takes a more aggressive stance and measures, unemployment will remain high and growth will stay at low, positive levels.

 

George Theocharides is the Associate Professor of Finance and Director of MSc in Finance & Banking at the Cyprus International Institute of Management (CIIM)

 

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