Europe as a headwind to the US economic recovery

Reuters

A protester carrying a banner that reads "No home, no job, no pension, no fear" withdraws money from an ATM machine of a bank next to graffiti sprayed by other protesters during a demonstration in Madrid April 7, 2011.

Article Highlights

  • In the year ahead, Europe will continue to constitute a major headwind to the US economic recovery.

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  • Europe's relentless increase in unemployment is giving rise to a political backlash against austerity policies.

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  • Rising unemployment in Europe will put further strains on Europe's social and political fabric.

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  • A troubling feature of Europe’s economic performance is the increase in unemployment among the youth.

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  • Overall youth unemployment in Europe is 24%, with youth unemployment in Greece and Spain now over 50%.

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In the year ahead, one must expect that Europe will continue to constitute a major headwind to the US economic recovery. For although financial markets have been calmed by aggressive European Central Bank policy action, Europe is presently embarked on the same policy mix of severe budget austerity, within a Euro straitjacket and within the context of a domestic credit crunch, that it applied last year. That policy mix must be expected to produce a deepening of the European economic recession in much the same way as it contributed to the economic recession in 2012. One should also expect that rising unemployment in Europe, particularly amongst the youth, will put further strains on Europe's social and political fabric that could interrupt the present calm in financial markets.

2012 was a bad year for Europe

Last year was a bad year for the European economy. Not only did the countries in the European periphery slide deeply into recession, but the economic contraction spread to countries in the European core. As a result, the overall European economy again moved into economic recession before having reached its pre-2008 peak (Figure 1). Of particular concern is the fact that in 2012 the Italian and Spanish economies contracted by 2 ½ percent and 1 ½ percent respectively (Figure 2). Meanwhile, the German economy, the locomotive of European economic growth, declined at a significant pace in the fourth quarter of the year.

A troubling feature of Europe’s recent economic performance is the steady increase in unemployment particularly  among the youth. Overall European unemployment has now risen to a record of 11.8 percent, while Greek and Spanish unemployment now exceeds 25 percent (Figure 3). More troubling yet, overall youth unemployment in Europe is 24 percent with youth unemployment in Greece and Spain now over 50 percent (Figure 4). The seemingly relentless increase in unemployment is giving rise to a growing political backlash against austerity policies particularly in the European periphery.

Weaker than expected economic growth in 2012 caused widespread budget underperformance in the European periphery. It also thwarted efforts to reduce public debt to GDP ratios to more sustainable levels. These conditions contributed to acute strains in the financial markets in the middle of the year that prompted a strong European Central Bank policy reaction. They also necessitated a further round of budget tightening in the periphery to bring those  economies back to a path of fiscal sustainability.

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