The Economic Outlook in the Euro Area: Good News from the Other Side of the Pond
Speaker: Servaas Deroose, Director, Economic Forecasting
Affiliation: European Commission, Brussels
Review of Remarks by Servaas Deroose,
April 20, 2006
Rapporteur: Diana Gehlhaus
Servaas Deroose’s talk focused on the past, present and future state of the euro area economy. The data he presented was the basis for his conclusion that the euro area economy is headed in a positive direction, with a favorable GDP growth forecast. The presentation was broken down into four main components including a ten-year snapshot of the euro area economy, the current recovery and recent developments, risks and challenges associated with the world market, and his conclusions for the future. He noted that when referring to the “euro area”, he was referring to 12 European Union member countries (out of 25) that have already adopted the euro (i.e., Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain).
In the first section, the snapshot of the euro area economy, Deroose started by comparing the euro area economy to that of the United States. It was shown that although GDP growth in the US has exceeded that of the euro area for the past decade (by an average of 3/4 of a point per year), substantial US population growth can partially explain the gap. Euro area population growth was not nearly as fast as in the US. In his discussion of the current situation, Deroose said that US productivity growth was higher but that the euro area experienced stronger employment gains.
In discussing the latest recovery relative to previous economic recoveries, Deroose showed that though this last recession was much shallower than previous downturns, the recovery has been slower than in the past, specifically by 2.6 percent of euro area GDP. Of the measured GDP components, domestic demand and exports have been lagging the most. Additionally, the recovery has been slightly held back by the appreciation of the euro. Referring to individual countries, Germany, Italy and the Netherlands have been the slowest to recover in comparison to the past.
Deroose then moved on to talk about the recent trends and growth-supportive forces of the strengthening recovery. He has a very upbeat outlook for GDP growth in 2006 despite weak growth in the last quarter of 2005. Deroose thinks that data discrepancies, specifically in adjusting working days and in Germany’s retail sales, were responsible for the low growth in Q4'05. He pointed out that upturns in the survey data, which are being seen currently, are normally followed by improvement in the data on the real economy. He is also optimistic about the recent gain in momentum of domestic demand within the euro area, even though individual household consumption numbers are still disappointing. Finally, Deroose said that loans to non-financial corporations over the past few years have significantly increased, which is typically indicative of strong investment.
Deroose also discussed the divergence of hard data (GDP, investment, etc.) and soft data (consumer confidence, economic sentiment surveys, etc.), saying that it was nothing to take too seriously. The discrepancy is usually not a big issue and works itself out over time. In reference to projected GDP, the data show no more than a ¼ point difference whether or not soft data surveys are included.
In support of his conjecture for euro area growth in 2006, Deroose showed many graphs visualizing the positive situation in the euro area. There has been and continues to be solid growth in world trade. Companies in the euro area have repaired their balance sheets, bringing down previously high levels of debt, which leaves them with more money to invest. Long-run interest rates, which are much more important in the euro area economy than short-term rates, are close to historical lows. This all bodes well for a boost in investment. The European stock market (Stoxx 50) has grown by 20 percent over the past year and continues to do well, especially in comparison to the slower growing market in the US. Euro area monetary policy, as well as the exchange rate, have also remained accommodative for growth. Finally, inflationary pressures have remained low despite the surge in oil prices. In fact, Deroose believes that euro area inflation will be under the EU target this year. Concluding this section, Deroose stated that the official EU estimate of 1.9 percent GDP growth for this year is simply too low. The next estimate will be released on May 8th.
In addressing risks and challenges, Deroose discussed the negative risks to the growth outlook, including surging oil prices. Though he was originally of the opinion that the latest rise in prices was only temporary, he now believes prices will remain at their current levels, or go higher in the foreseeable future. Currently, Deroose estimated gasoline to cost around $5/gallon in Europe. However, he said that this has not affected consumers as much as it may seem, since energy consumption is half as much in Europe as it is in the US. Additionally, Deroose pointed out that energy has been expensive in Europe for many years, so people have already adjusted their lifestyles accordingly by reducing consumption, unlike in the US where sudden high prices have decreased purchasing power, causing a market shock. However, subsequent increases will have a greater marginal effect on the euro area economies than in the past, since prices are reaching their saturation point, meaning people and governments have adjusted as much as they can without being negatively affected by higher prices.
The euro area has had, and continues to have, a relatively balanced savings-investment ratio between the public and private sector, leaving a minimally positive, flat account balance. Global spending imbalances can be partially explained by the rather large negative account balance of the United States. Global account imbalances pose a risk to the euro area growth because they could cause abrupt changes in the euro exchange rate.
Another risk factor in discussing euro area growth is the housing (real estate) market. Real house prices have surged in some member states while remaining constant in others, causing debt to be particularly high in some member states. For example, the Netherlands has a very high debt-to-disposable-income ratio. However, Deroose pointed out that although there have been some surges in euro area housing markets, they are still comparatively less than the surges recently experienced in US states like California and New Jersey. The same can be said for the average euro area level of household indebtedness relative to GDP.
Although employment growth continues to be strong for the euro area (more than two times as many jobs were created than in the US over the last six to eight years), average unemployment levels for the region are still around 8.5 percent (according to the EU measurement methodology). Reforms to improve this rate (getting rid of rigid labor laws to give more flexibility to employers) are hard to pass because societies are not supportive. Some euro area countries have more problems in this regard than others. Deroose predicts that any time GDP growth is more than two percent there will be job growth, which he is hopeful for in this year’s projections. He noted that countries such as Italy and Germany, which have positive job growth but weak and lagging economies, are hard to explain. A big problem the European Monetary Union (EMU) has to deal with is what to do with monetary policy when some economies are growing strongly and others are slower or stagnating.
Deroose believes that globalization is a very positive thing for world economies. Already, China has helped decrease euro area prices, and low inflation yields more spending. The euro area is in a good place competitively with other world markets, and Deroose sees no reason why it will not stay that way. Strong growth in one major world economy, such as China, should not be worrying. What would help cure global imbalances is if China would decrease its growing savings and invest money in foreign markets, while continuing to open its own. This would help to correct global current account imbalances.
Deroose pointed out the internal and external factors that continue to pose a risk to the euro area economy, many of which should be taken seriously. Surging oil prices and housing markets within euro area member states are two things to keep a close eye on in the short term. Additionally, the various policies and economies among the euro area member states can make analysis and forecasting difficult. However, given the above evidence, Deroose is confident that the euro area will experience solid GDP growth in 2006. Similarly, investment levels and employment growth also appear to be headed in a positive direction, and hopefully household consumption levels will be soon to follow. The euro area is the right track to continued and strengthening recovery from the last recession.