Euro area growth projections downgraded, and policy mix still restrictive – My weekly column

The OECD and the ECB have downgraded their 2019 growth projections for the euro area in quick succession, with the OECD now expecting 1% for the year ahead vs. 1.8% previously, and the European Central Bank projecting 1.1% vs. 1.7% in December, putting euro area growth below its potential pace.
The main reason for this rapid slowdown of the activity lies in the rapid deceleration of world trade, particularly in its Asian component. The White House policy is a key explanation of this trend change. This external shock profoundly modifies the equilibrium of the euro zone economy.

The OECD believes that the economy in the bloc has now become a source of concern for the world economy as a whole. Beyond the euro area’s actual situation, a slowdown in the zone along with a sharp and swift downgrade to growth projections for 2019 also make for a shock on world growth. The area is a major contributor to world trade momentum, so a drastic slowdown is an additional source of concern for the world economy.
It is worrying that the euro area is so large, but yet it is still at the mercy of international events with little capacity to react to them clearly. It was buoyed by strengthening trade in 2017 but was dented by the recent negative shock, and its inability to absorb these tremors is alarming for the world as a whole and not just the European economy.

This situation reflects the fact that the area has become more and more open to outside influences, while for example the United States’ exposure to trade with the rest of the world has remained steady over time. Germany plays a major role in this trend, as shown by the chart, while Italy and France are similar in terms of how open their economies are to trade with outside countries

The most surprising aspect during the current downgrades to growth projections is that this swift drop reflects the dearth of economic policy to cushion the shock.

The policy mix – i.e. the way fiscal policy and monetary policy work together – is restrictive. Financial conditions are admittedly encouraging as a result of the ECB’s accommodation, but fiscal policy has been restrictive for too long and is not propping up economic activity, meaning that the shock from the world economy is in no way cushioned by euro area economic policy.

The chart shows the primary budget balance (excluding interest payments) adjusted for the economic cycle and expressed as a % of potential GDP. This figure is an indication of how restrictive fiscal policy is, and in the euro area the balance is positive, pointing to restrictive policy.

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