Post-crisis policies: getting it right in the Eurozone

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●  Laggard again? Will the Eurozone get its policies wrong again and fall far behind the US in the rebound from the COVID-19 recession? Pointing to the experience of Europe’s hesitant post-Lehman recovery, some observers worry that a sub-par fiscal stimulus, a premature fiscal tightening and the hawkish inclinations of some ECB policymakers may once again hold back the Eurozone.

●  A persistent gap: These concerns contain a kernel of truth. After weathering the recent winter wave of the pandemic with fewer restrictions than the Eurozone, the US will likely maintain a small advantage in the pace of growth over the Eurozone into 2022. Having received very generous government transfers in 2020 and early 2021, households in the US have accumulated even more excess savings than those in the Eurozone. With the reopening of economies, some of these excess savings will be spent over time. That will give US consumption an edge for a while.

●  But the pessimists miss the key point: Whereas the Eurozone will not grow quite as fast as the US, in our view, we expect the region will still do rather well. Most economic data are surpassing even our optimistic expectations. After returning to its pre-COVID level of GDP in late 2021, the Eurozone economy will likely continue to expand at a rate above its pre-COVID trend in 2022 and beyond. Like other parts of the advanced world, the Eurozone could be on track for a Golden Twenties.

●  Getting the policies right: Abstracting from a few tactical errors, the Eurozone got its economic policy response to the COVID-19 emergency right. The ECB reacted fast and aggressively. In textbook fashion, fiscal policy kept real disposable incomes roughly constant during the downturn, furlough schemes prevented mass layoffs and support for companies helped preserve the economy’s supply potential.

●  Staying on the right track: We see no sign of a major policy mistake to come. The ECB’s guidance indicates an ultra-loose monetary for years to come even if asset purchases can be scaled back gradually as the economy rebounds. Courtesy of the EU’s €750bn recovery fund, fiscal policy in the Eurozone will likely be at least as expansionary as in the US going forward. Whereas the oft-discussed fiscal rules are either suspended or applied flexibly, we see little political appetite for any serious fiscal tightening at the national level. Instead, the public debt trajectory is more challenging and tax hike risks loom larger in the US than in the Eurozone.

Holger Schmieding

Chief Economist

+44 7771 920377

holger.schmieding@berenberg.com

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This material is intended as commentary on political, economic or market conditions for institutional investors or market professionals only and does not constitute a financial analysis or a research report as defined by applicable regulation. See the "Disclaimers" section of this report.

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