EMU: Recovery or Decline?

NY Times recently reported on the agreed financial rescue assitance to Grecce from EMU (€110 billion) and IMF ($145 billion). Alongside Ireland and Mediterranean countries, the economic recovery of EMU is hampered by a high mountain of public debt and unfavorable macroeconomic data on growth, employment and current account.

Public debt in the European Union in 2009

Source: Eurostat (2009)

The graph I attached, shows the level of public debt in EU countries in 2009. Solid horizontal blue line shows the 60 percent debt-to-GDP ratio required by Maastricht criteria for each EMU entrant.

The underlying data (link) on economic recovery in the US point out a strong and robust recovery. The data from Bureau of Economic Analysis show that the US economy grew by 3.2 percent in Q1:2010 continued from a remarkable 4.6 percent growth in Q4:2009. While private consumption expenditure growth increased by 2 percentage points from the previous quarter, private domestic investment rebounded by 14.8 percent in Q1:2010 after a remarkable 46.1 percent increase in Q4:2009. In addition, labor productivity in Q4:2009 increased by 6.9 percent – the largest quarterly increase since Q3:2003 (link) On the other side, recent revision (link) of quarterly growth rate in the EMU has shown that quarterly GDP in Q1:2010 increased by 0.0 percent, revised from 0.1 percent. Industrial confidence, an important measure of manufacturing outlook, further decline by 12.2 index points.

The macroeconomic outlook for the EMU is downsized by high public debt and negative budget deficit which led 10-year bond premium spread between EMU economies and Germany (link). The premium spread between Greece and Germany stood at 8.57 percentage points on April 28 while the spread between Ireland and Germany was at 2.54 percentage points.

High level of fiscal deficits restrains the economic recovery of the EMU countries. In 2009, Spain, Ireland and Greece faced the highest deficit-to-GDP ratio while Denmark’s 2 percent deficit-to-GDP ratio was the lowest in the European Union. NY Times recently collected annual dataset on public debt and budget deficit (link) in which an overview of key public finance indicators is availible.

The prospects of economic recovery in the EMU are further downgraded by unfavorable growth forecast. One of the key questions during the ongoing debt crisis has been whether the EMU will sustain fiscal discrepancy within the EMU since asymmetric fiscal policy undermine the ability of the common monetary policy. Even though Greece’s debt crisis is the core of the debate regarding future viability of the single currency, growth estimates for Spain and Italy in 2010/2011 will determine the mid-term macroeconomic stability of the eurozone. European Commission recently updated the quarterly economic growth estimates for eurozone countries (link). Depending on the absorption of financial market spillovers into investment and net exports, economic growth estimates for Italy and Spain are quite pessimistic. After an estimated 0.1 percent growth rate in Q2, Spain’s economy is likely to contract in Q3 by -0.2 percent and experience a slight rebound in Q4:2010. Quarterly economic forecast for Italy is positive throughout the year although the economic growth rate is likely to be close to zero. However, Italy’s economic growth rate is likely to keep the increasing pace towards the end of the year although current macroeconomic outlook deters consumption, investment and inventories’ contribution to GDP growth mainly because of high unemployment rate and sluggish productivity growth.

Robust economic growth is essential to the cure of high public debt. Since EMU countries have adopted a single currency, policymakers cannot trigger exchange-rate adjustment through currency depreciation. The latter would spill into higher inflation and modestly reduce the volume of public debt. Due to high unemployment and slower recovery of inventories, inflation rate is unlikely to rebound to pre-crisis levels.

EMU’s most problematic countries’ recovery is unlikely to be robust given public debt and deficit constraint on quarterly growth outlook. Without a prudent fiscal tightening, lower government spending, there will be a bleak economic outlook for the future of EMU countries which could result in a decade-long period of low growth, high unemployment and Japan-styled deflationary persistence.

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