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Thursday, 25 September 2014

UPDATE: The state of the European economy

Recently, Europe’s economy has avoided appearing on many of our news screens what with other international affairs such as Russia/ Ukraine, Syria and Iraq in the headlines for probably my entire summer holidays. But that doesn't mean that the European economy is all hunky-dory and the recession is a thing of the past.

This post is an update of what is actually going on in Europe right now, giving you three key case studies: Italy, France and Germany.

Italy

·      Triple dip recession – GDP fell by 0.2% in the second quarter of 2014
·      12.6% unemployment rate
·      43% youth unemployment
·      Little political will to do anything about it

France
·      Rising budget deficit
·      Last quarter’s GDP growth: 0%!
·      Chance of going back into recession, was also 0% in the quarter before last

Germany
·      GDP fell 0.2% in the last quarter, the first GDP contraction this year
·      Manufacturing sector slow down
·      Geopolitics is affecting growth: Russia’s embargo on European food imports is apparently affecting 9.5m European farmers, and is affecting Germany’s trade


Key points to note about Europe right now:

·      Low inflation.
Average Euro Area: 0.4%
Deflation in 8 Eurozone countries including the PIGS (Portugal, Italy, Greece and Spain)

Country in Eurozone
Inflation rate
France
0.4%
Italy
-0.1%
Germany
0.8%
Spain
-0.5%
Greece
-0.3%
Portugal
0.4%

Why is this a problem?

·           Increases the real value of debt which means that government debt increases making it harder to pay off and increasing the likelihood of needing another bail out
·           Taxes will have to rise eventually to fund the increased debt accumulation which means businesses will have a higher tax burden à leaving some Eurozone countries
·           There is danger of falling into a deflation trap where prices just keep falling. This is called a deflation spiral.

·      High unemployment

·      High government debt

·      Political upheaval

·      Geopolitics with Russia

·      Lack of political union
Different countries in the Eurozone want different things and have different views with how situations should be handled, e.g. with Russia, which makes it hard to manage economic policy and introduce austerity measures where needed.

What can be done?

·           Keep interest rates low – increasing interest rates will just decrease inflation more
·           Quantitative Easing lite”: the European Central bank buys assets to stimulate the economy and help inflation rise

Anything else?
·           Role of competition in markets:
o   There was a period of very low inflation during the late 19th century in Germany and the UK
o   Analysis shows there was competition in markets and businesses operated in a competitive environment
o   Competition restricts wage growth because there are many companies in the same industry offering the same job and the same wage. This is happening now!!!
o   A competitive market means that firms are unwilling to increase the price of goods and services – preventing inflation from rising. This is happening now!!!
o   It is therefore hard to increase inflation. This is happening now!!!