A recession in the US appears imminent by now. Will Europe follow or can it ‘decouple’? So far the ‘sub prime’ crises has affected European financial markets at least as much as those of the US although there is general agreement that in Europe there has been very little sub prime lending. It might thus be useful to take a look at how the euro zone business cycle has been related to that of the US over the last ten years.
The academic community seems to think that the euro zone does not necessarily follow the US. Following the example of the US, The leading Business Cycle Dating Committee was established some time ago for the Euro zone by the Centre for Economic Policy Research (CEPR). (Following the example of the US where the NBER dates officially the business cycle.) Its central finding (published in September 2003) was that “there is no clear pattern of lead-lag relation between the US and the Euro-area”.
There are two reasons behind this finding:
1) The US experienced (a short lived) recession in 2001, but not the Euro area. In the US GDP declined for three consecutive quarters after the peak of 2000q4, with a cumulative decline in that period of -0.62%, the cumulative change of Euro area GDP from 2001q1 through 2001q4 was still positive, even if marginally so (+0.1%). However, this does not imply that the euro zone fared better than the US in terms of growth since the US rebounded quickly after the recession whereas growth continued to remain sluggish in the euro area for much longer. The US slowdown was thus short and sharp (conforming to the technical definition of a recession) whereas in Europe the slowdown was shallow and longer. Figure 1 shows also that in terms of GDP growth the euro followed the US rather closely from a common peak in 2000 to a trough in 2001 (the annual growth rate never became negative for the US because of the quick rebound following the technical recession of 2001).
2) A more important reason why at least formally one cannot establish a close correlation of business cycles concerns the evolution of employment. In 2001 in the euro area employment continued to grow (up about 1 %), whereas it fell sharply (by about 2.5 %) in the US. This pattern seems to continue in the most recent data (see figure 2) with employment growth holding up in the euro area, but falling sharply in the US. This relative strong performance of employment in the euro area might be the main reason why there have so far been few calls for fiscal boosts in Europe (see also comment by S. Dullien).
What does this brief examination of the past suggest for the current situation? The goods news is that the euro zone should be able to avoid a technical recession and that employment growth is likely to remain relatively robust. Having a more sluggish economy has its advantages during bad times. The bad news is that any recovery might also be much slower in starting in Europe.
One important aspect of how business cycles are experienced in real time (as opposed to how they look in retrospect) is that the data that are available in real time consist typically of first estimates which tend to exaggerate the size of the downturn. This is illustrated in Figures 3 and 4, which show that for both employment and GDP growth the first estimates suggested that the euro area was in, or very close to, a recession in 2001, but subsequent data revisions, mostly upwards, did not support this view. This pattern makes a timely policy response even more difficult to calibrate. At the very least one should take these important data revisions as a warning against policy activism.