Nouriel Roubini's Global EconoMonitor

Europe’s Short Vacation

Since last November, the European Central Bank, under its new president, Mario Draghi, has reduced its policy rates and undertaken two injections of more than €1 trillion of liquidity into the eurozone banking system. This led to a temporary reduction in the financial strains confronting the debt endangered countries on the eurozone’s periphery (Greece, Spain, Portugal, Italy, and Ireland), sharply lowered the risk of a liquidity run in the eurozone banking system, and cut financing costs for Italy and Spain from their unsustainable levels of last fall.

At the same time, a technical default by Greece was avoided, and the country implemented a successful – if coercive – restructuring of its public debt. A new fiscal compact – and new governments in Greece, Italy, and Spain – spurred hope of credible commitment to austerity and structural reform. And the decision to combine the eurozone’s new bailout fund (the European Stability Mechanism) with the old one (the European Financial Stability Facility) significantly increased the size of the eurozone’s firewall.

But the ensuing honeymoon with the markets turned out to be brief. Interest-rate spreads for Italy and Spain are widening again, while borrowing costs for Portugal and Greece remained high all along. And, inevitably, the recession on the eurozone’s periphery is deepening and moving to the core, namely France and Germany. Indeed, the recession will worsen throughout this year, for many reasons.

First, front-loaded fiscal austerity – however necessary – is accelerating the contraction, as higher taxes and lower government spending and transfer payments reduce disposable income and aggregate demand. Moreover, as the recession deepens, resulting in even wider fiscal deficits, another round of austerity will be needed. And now, thanks to the fiscal compact, even the eurozone’s core will be forced into front-loaded recessionary austerity.

Moreover, while über-competitive Germany can withstand a euro at – or even stronger than – $1.30, for the eurozone’s periphery, where unit labor costs rose 30-40% during the last decade, the value of the exchange rate would have to fall to parity with the US dollar to restore competitiveness and external balance. After all, with painful deleveraging – spending less and saving more to reduce debts – depressing domestic private and public demand, the only hope of restoring growth is an improvement in the trade balance, which requires a much weaker euro.

Meanwhile, the credit crunch in the eurozone periphery is intensifying: thanks to the ECB long-term cheap loans, banks there don’t have a liquidity problem now, but they do have a massive capital shortage. Faced with the difficulty of meeting their 9% capital-ratio requirement, they will achieve the target by selling assets and contracting credit – not exactly an ideal scenario for economic recovery.

To make matters worse, the eurozone depends on oil imports even more than the United States does, and oil prices are rising, even as the political and policy environment is deteriorating. France may elect a president who opposes the fiscal compact and whose policies may scare the bond markets. Elections in Greece – where the recession is turning into a depression – may give 40-50% of the popular vote to parties that favor immediate default and exit from the eurozone. Irish voters may reject the fiscal compact in a referendum. And there are signs of austerity and reform fatigue both in Spain and Italy, where demonstrations, strikes, and popular resentment against painful austerity are mounting.

Even structural reforms that will eventually increase productivity growth can be recessionary in the short run. Increasing labor-market flexibility by reducing the costs of shedding workers will lead – in the short run – to more layoffs in the public and private sector, exacerbating the fall in incomes and demand.

Finally, after a good start, the ECB has now placed on hold the additional monetary stimulus that the eurozone needs. Indeed, ECB officials are starting to worry aloud about the rise in inflation due to the oil shock.

The trouble is that the eurozone has an austerity strategy but no growth strategy. And, without that, all it has is a recession strategy that makes austerity and reform self-defeating, because, if output continues to contract, deficit and debt ratios will continue to rise to unsustainable levels. Moreover, the social and political backlash eventually will become overwhelming.

That is why interest-rate spreads in the eurozone periphery are widening again now. The peripheral countries suffer from severe stock and flow imbalances. The stock imbalances include large and rising public and private debt as a share of GDP. The flow imbalances include a deepening recession, massive loss of external competitiveness, and the large external deficits that markets are now unwilling to finance.

Without a much easier monetary policy and a less front-loaded mode of fiscal austerity, the euro will not weaken, external competitiveness will not be restored, and the recession will deepen. And, without resumption of growth – not years down the line, but in 2012 – the stock and flow imbalances will become even more unsustainable. More eurozone countries will be forced to restructure their debts, and eventually some will decide to exit the monetary union.

This post originally appeared on Project Syndicate and is reproduced here with permission.

24 Responses to “Europe’s Short Vacation”

Rassegna web: il QE ha dato inizio alla guerra della liquidità « Trading WarriorsApril 15th, 2012 at 2:48 pm

[…] Iniziamo dall’intervento più recente di Nouriel Roubini. Le iniezioni di liquidità implementate dalla Bce sotto la regia di Mario Draghi con i due round di LTRO sono soltanto dei palliativi temporanei, e in ogni caso un’arma spuntata se la si confronta con la strategia non convenzionale adottata da Bernanke attraverso il Quantitative Easing. Altro il volume di fuoco, altri gli effetti di lunga durata. Doctor Doom corrobora il consueto quadro negativo aggiungendo che la maggiore dipendenza dalle importazioni di greggio penalizza l’Europa assai più degli USA, come dire: la recessione è appena iniziata, e l’LTRO è stato un solenne fallimento. (read more on […]

diatoo1April 15th, 2012 at 6:57 pm

Why don`t you propose to Germany and the EU to let Germany impose some export taxes in suitable cases. It reduces the German competitiveness and is also good for Germany by improving its terms of trade.

Mark AllanApril 16th, 2012 at 3:16 pm

When,oh when will those people “running” Europe face up to the fact that something needs to be done and fast. No more time can be bought,the can,can be kicked no further.
They insist on austerity so as not to spook the markets,well when these countries can’t meet their debt repayments because of no growth due to these measures,spooking the markets will be the least of their worries!
I predict a run on the banks and massive social unrest. The powers that be think this will end orderly and civily and yet the longer they leave it the bigger the fall out.
What happened post Lehman will be a tea party compared to whats coming if this problem is not got to grips with.

Mcalester WatercoolerApril 17th, 2012 at 12:26 am

That would be enlightened self- interest — we do not have a world economic system that encourages that — in fact it promotes 'unenlightened self-interest' — the REAL cause of all the problems/

Tilak RatnayakeApril 17th, 2012 at 2:14 am

NR is very close to reality in his economic projections & analysis.SIting at his laptop he seems to feels the grass at his feet & smells the air.A truly world class economists.

Aegean1972April 17th, 2012 at 6:34 am

The article is SPOT-ON!

Europe didnt learn anything from Greece (the guinea pig) and now they are trying to put out a (starting) euro-forest fire with garden hoses. The situation is europe is going to get bad. I didnt say "worse". I said bad. And bad is worse "x 3".

Prepare for many "Greece's" throughout Europe. Even in the core. While Greece is already in depression, europe falls into recession. when Europe (2 years from now) is in deep recession, i dont know where Greece will be. The solution is:

1) Immediate help for growth in Greece (stimulous packages), before the May elections elect a 50% communist/anti-europe parties. An anti-european gvmnt in Greece can trigger an exit from the EU (in less than a year) and that will bring things to a critical level for the whole of the EU with other periphery exits following and political chaos starting all over the EU.

2) Eurobond in less than a year from now.

3) Growth strategy for all of Europe.

anything less than the above, will result in massive political chaos in Europe and of course around the world.

reallyApril 17th, 2012 at 5:01 pm

Paragraph 2 states that Greece avoided a technical default, but according to the International Swaps and Derivatives Association there was one and CDS was triggered.

princess1960April 17th, 2012 at 7:28 pm

i think EUROPE is deep in crisis.GR is not out .SP is very deep IT is very unsafe (after SP)we will see after BELG..AUST and GER FOR SOME REASON ??? GET MONEY..what you can tell me about my comment please.. THANK YOU

Aegean1972April 18th, 2012 at 6:32 am

Europe doesnt need more taxes. It needs growth.

The periphery (Greece, etc) needs to get organised (no doubt about that), but not with more hard-core austerity measures. The German recipe of "discipline and bondage" has failed MISERABLY in Greece. 60% of small businesses have closed and unemployment is up to 25% (unofficially) and 45% betweent the ages of 25-30.

Puhsing them even more will mean political chaos and an exit from the EU. And we all know what that will trigger. Italy and Spain are NOT much different than Greece. They think they are, but in reality they are NOT. And if Greece can be saved with 400 billion, IT and SP cant be saved with over 2 trillion. Does the IMF and ECB have that much money (2 trillion) to spent in 2012 to save those two? Because it seems like the situation is getting there.

when money was "flowing" around Europe (at the start of the millenium), Germany was kind enough to all the periphery, because it was selling trillions of German products to them. But now Germany isnt willing to make the effort of saving europe, with a eurobond.

John ClarkApril 18th, 2012 at 11:22 am

It seems that the US economy is doing splendid. The US shifts is focus way too often to Europe to distract from its own problems (15 tril $ debt).

The only way Europe or better, the Euro can survive is to kick PIIGS out of the Euro zone. Alternatively, discontinuation of the Euro. The idea is good, the results are worse.

magicPaul2012April 18th, 2012 at 9:04 pm

Te US want's us all to be capitalist, dominating idiots – all talk where there's a profit but no action or philanthropy at a cost………..

paul arcidiaconoApril 21st, 2012 at 8:44 pm

So some countries will exit the European monetary union.

The effects of such an exit by one or several countries on Europe, the United
States and the rest of the global economy remains to be seen.

WHY is the European Union continuing to lurch towards its own breakdown?
What may this inform us of the premises/inner workings /limitations of the European Union?

benleetApril 23rd, 2012 at 9:10 pm

From an article in Dollars and Sense magazine: "German “unit labor costs” (or compensation per unit of output) hardly rose after 2001. Unit labor costs rise with wage increases that push up costs and fall with gains in productivity that lower costs. But with the new German labor market policies keeping wage growth in check, German unit labor costs in 2010 (including benefit costs) were just 10% higher than they had been a decade earlier.

As a result, despite posting better productivity gains than Germany, the southern eurozone economies of Greece, Portugal, Spain, and Italy saw unit labor costs and prices rise considerably more quickly than they did in Germany. By the end of the decade wage gains in those four Southern Eurozone economies pushed up their unit labor costs by one-third.

The huge gap in unit labor costs gave Germany a tremendous competitive advantage and left the southern eurozone economies at tremendous competitive disadvantage.", Article's title, "Why the US is not Greece" by Miller and Sciaccitano. Internal EU trade imbalances have exacerbated the crisis. The meaningful remedy would not be increasing EU exports, though that might help.

G HendersonMay 4th, 2012 at 9:04 am

That word "growth" is perhaps the least understood word in the English language!
The former UK prime minister Gordon Brown and his friends in Southern Europe financed it with borrowed money and George Bush with an unregulated financial services boom.
Neither of which should have been allowed to happen and are now the direct cause of our present problems.
What to do now?
Money needs to be spent by people in order to stimulate the economy—but many people do not have any money and their access to credit has sharply declined–and the people with money are not spending, choosing instead to save it.(ie Germany and Japan)
Many European governments have run up debt so high it can never be paid off by conventional means so the old short term cure of a Government Stimulus is a thing of the past.
And yet notwithstanding all these problems we have an even bigger one–The Euro–you just could not write a script like this!
We need an internationally agreed 10 year program of Government debt write downs financed by QE/Money printing.If we do this together out in the open it will work.

Yann BMay 7th, 2012 at 1:27 pm

I have a naive solution maybe to the weaker euro conundrum! Germany does not want to devalue the Euro because it would be a free bailout to EU countries that were too wasteful.
Why not give Euros to the german state and ask them invest it abroad? This would increase the monetary base and thus devalue the Euro and the germans would love it because they get Capital which they can invest in emerging markets. I was really proud of myself when thinking about this! can someone please tell me why I am wrong?

travel trailersMay 16th, 2012 at 5:46 pm

Even structural reforms that will eventually increase productivity growth can be recessionary in the short run. Increasing labor-market flexibility by reducing the costs of shedding workers will lead – in the short run – to more layoffs in the public and private sector, exacerbating the fall in incomes and demand.

guestMay 18th, 2012 at 11:23 pm

India will soon see the downturn in next 1 or 2 years .
The politics are doing nothing either be India shining or dooming , they are fooling poor for petty votes and looting the public money so when the recession comes , they still can afford luxury.
The market cycle has been 1992-2000-2008-2016 ????

Bangladesh hotelJune 6th, 2013 at 8:24 am

You did really nice allocation about Europe’s Short Vacation. I'm a traveler and frequently make travel in different country of this world. Your information will surely be handy for me to visit in Europe. Thanks mate.

bohol packageJune 18th, 2013 at 10:22 am

i love going to Europe for a short vacation if actually be given a chance. Now this time i guess would be the best for me and i can't really take it on the first place.