Euro is still a recession away from disaster
US policy response to financial crisis has proven to be far more effective
The ECB headquarters in Frankfurt. Despite the two quarters of grinding growth, the size of the euro zone economy is still smaller (by 0.4 per cent) than at the same time last year. The recovery, such as it is, is fragile. Photograph: Kai Pfaffenbach/Reuters
The euro zone economy grew by 0.1 per cent in the three months to end-September, it was announced yesterday. That this was in line with market expectations says plenty about how pessimistic we all are about Europe’s growth prospects. At least it is a second consecutive quarter of growth, following six quarters of shrinking output. But, despite the two quarters of grinding growth, the size of the euro zone economy is still smaller (by 0.4 per cent) than at the same time last year. The recovery, such as it is, is fragile.
Amidst all the carnage of the global financial crisis and its associated “Great Recession”, a remarkable policy experiment has been taking place. One of the reasons why economics only holds pretensions to be a science is that we can’t usually conduct laboratory experiments. Controversies about economic policy are always about what would have happened; the unobservable results of doing something different. Usually, we only observe one policy choice. So the arguments are always about purely hypothetical things that might have happened if only we had pushed a different policy lever.
The last great natural policy experiment took place in the 1930s. Then, lots of different countries all did similar things and achieved similar results. It was a study in scientific replication – tight fiscal and monetary policies always and everywhere made things worse.
There were enough data points from this duplication of experiences to convince virtually all economists – of all ideological persuasions – that bad policy turned recession into a depression. Contrary to some popular accounts, economists can agree on something; the 1930s were a policy-induced disaster. Such unanimity is rare, because policy experiments of a 1930s kind – good or bad – rarely occur. The real world is not a suitable lab for testing economic theories. Until recently.
The financial shock that followed the bursting of property and other asset bubbles was common to many countries, particularly in Europe and the United States. The policy response was very different: we had a common shock to our economies and the authorities in different jurisdictions responded differently.
The results are very striking.
Take a look at the profile of GDP growth in the euro zone starting in 2005 and look at what happens up to the first quarter of 2009 when the financial crisis was at its height. In the early part of the period, we see (quarter on quarter) growth typically between 0.5 per cent and 1 per cent. Then growth collapses. Essentially, the US traces a very similar path.
Both regions staged a rebound within a year – back to those earlier growth rates. From then until now, the US has broadly sustained these growth rates – not much to write home about but sufficient to drive unemployment down to 7-8 per cent.
In the euro zone, by contrast, that initial recovery from the financial shock very quickly faded. By the start of 2011, there was barely any growth at all. Then we observe six consecutive quarters of negative growth – GDP fell, sequentially, for a year and a half, until the second quarter of this year.
The US had fiscal and monetary expansion. Europe did not. The US staged an economic recovery proportionate to the stimulus it received; so did Europe. The respective economic performance is a powerful testimony to how effective fiscal policy can be when interest rates are close to zero. Again, despite all appearances to the contrary, there is near-unanimity in the economics profession about this. Normally, we should use interest rates to steer the business cycle – when things are abnormal, when interest rates are zero, use fiscal policy.
Now that the US has tightened fiscal policy over the past few months, guess what? There are preliminary signs that the economy is once again slowing. Britain, having more-or-less given up on fiscal austerity, is now growing strongly again.
In both the US and Britain, unemployment rates of between 7 per cent and 8 per cent are regarded as a complete disaster, meriting policy responses of a textbook kind. It couldn’t be more different in the euro zone. This, I suppose, is more about politics than economics but I don’t understand why a wilful ignorance of basic economics and a toleration of double-digit unemployment makes for good politics.
If growth falters over the next couple of years, the euro crisis will resume. We are still one recession away from disaster.