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Confidence in a 2014 recovery appears to be misplaced.
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At the start of each of the past three years, European policy makers have confidently assured the world that the worst of the debt crisis was over and that their economies were finally on the mend. Yet, at the end of each of the past three years, Europe has been marked by higher unemployment, greater public debt and a more troubled political environment.
Undaunted, both European Central Bank (ECB) President Mario Draghi and European Commissioner for Economic and Monetary Affairs Ohli Rehn are now once again declaring that Europe has finally turned a corner and that a sustained economic recovery is underway. They are also asserting that there is absolutely no risk that any of the euro zone’s 17 member countries might exit the monetary union. Sadly, there are all too many reasons to think that their confidence will prove to be as misplaced in 2014 as it has been in the past.
A principle reason for this pessimism is that Europe’s macroeconomic policy setting is not conducive to a sustained economic recovery. Europe’s longest economic recession in the postwar period only ended in the middle of 2013, having brought unemployment to a record 12.3%. Underlying all this was the pursuit of budget austerity and the onset of a severe credit crunch, which led the ECB to a more restrictive monetary stance. To compound matters, these policies were being pursued within the euro-zone straitjacket, which precluded currency depreciation.
Yet in 2014, budget austerity—albeit of a lesser degree—will continue to be applied by most euro countries. This will be done in pursuit of the longer term goal of attaining structural budget balance. At the same time, there is every reason to fear that Europe’s credit crunch, which has already resulted in the fastest pace of credit contraction in the euro zone’s 15-year history, will intensify in the year ahead, since little is being done to recapitalize European banks ahead of the ECB’s asset-quality review exercise. That exercise, which will be completed by the end of 2014, will induce European banks to de-leverage at an even faster pace than in 2013.
Absent a meaningful economic recovery, Europe’s unemployment rate will continue to hover at close to today’s record level. Even the ECB and the European Commission are projecting that EU unemployment will remain stuck at close to 12% by the end of 2015.
The persistence of high unemployment would heighten the risk that the debt crisis will erupt again in the year ahead. Persistently high unemployment risks driving the countries on the European periphery into a deflationary trap. Deflation would make it all but impossible for countries such as Greece, Italy, Portugal and Spain to work down their debt-to-GDP ratios in the both the public and private sectors.
Persistently high unemployment is also likely to exacerbate the marked deterioration in the political climate that has already occurred in Europe. Signs of austerity fatigue are all too evident in France, Greece, Italy, and Portugal, where there has been a sharp erosion of public support for centrist parties and a corresponding surge in the polls for populist extremists on both the left and the right. This does not bode well for forthcoming European parliamentary elections in May 2014, which could register strong anti-European sentiment at the ballot box.
It would be comforting to believe European policy makers’ soothing reassurances about the economic and political outlook. However, if their past forecasting record is a prologue to the future, one would be mistaken to take them too seriously.
Mr. Lachman is a resident fellow at the American Enterprise Institute.
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