A Pessimistic Note on the Euro

On February 7, I gave a talk a the Conference “America: Still A European Power?” in Bologna jontly organized by Johns Hopkins University-SAIS and Bologna University.
(a more elaborate version of this post was later posted on
voxeu e linkiesta )
The title of my presentation was “Why and How the US and the EU Did/Didn’t Come out of the Economic Crisis”. Putting my notes together, I  realized that they gave quite a pessimistic view on the sustainability of the Euro as we have come to know it. This is, more or less,  what I said.

 In this talk I will compare how the US and Eurozone countries (EUZ) were affected by and responded to the crisis. Thus I will not say a word on the “causes” of the current crisis. I will argue that the main differences rest in three key aspects:

  1. permanent vs transitory consequences
  2. active vs passive policy responses
  3. symmetric vs asymmetric shocks

 I will then briefly  discuss some policy implications such as

  1. Is the Euro sustainable?
  2. What institutional reform are required?
  3. Are current reforms (Banking Union, Political Union, Eurobonds) steps in the right direction? 

I. The Economy 


Source: P.Manasse calculations on WEO

The figure on the right compares the US (red) and EUZ (blue) GDPs since 2006 (at constant prices, source WEO database October 2012), where I have normalized the initial values to 100 (click to enlarge). The figure shows that

  • The US recession starts earlier than EUZ  due to the subprime crisis;
  • the EUZ recession is deeper on impact;
  • the US recovers from 2009, while the EUZ’s recovery is short lived  and  ends in 2010;
  • In 2012 output is above it’s 2006 level by 7% in the US and only by 2% in EUZ


Source: P.Manasse calculations on WEO
  • After a sharp rise  in 2007-8 unemployment in the US  declines in 2010, but there is little progress thereafter;
  •  unemployment in EUZ keeps rising with no sign of reversal

 Thus we have evidence that the crisis so far has much more persistent effects in the EUZ than in the US. It seems that we are in for another round of “hysteresis” in Europe, similar to what happened after the first oil shock in 1973.
The question is to what extent this reflects different policy stances in the EUZ vs the US or other factors.

II. The Policy Stance

Fiscal Policy: Deficit and Debts
While the ratio of government budget deficit to GDP cannot be interpreted as an indicator of discretionary fiscal stimulus, it’s  nevertheless interesting to compare the US and EUZ numbers.

Source: P.Manasse calculations on WEO
  • the rise in deficit/GDP ratio in the US (a downward jump in the line) is much more pronounced than in the EUZ (12 vs 5 points of GDP from peak to trough) , and this occurs despite the deeper recession in Europe (which lowers GDP and raise the deficit due to automatic stabilizers);
  • the “expansionary” stance in the EUZ is short lived, and reverts as soon as 2009
  • Source: P.Manasse calculations on WEO
  • As a consequence, the rise in the debt/GDP ratio is much larger in the US than in the EUZ (see Figure on the right) 

Monetary Policy
The next picture is borrowed from Gros et al (2011). It compares the Fed’s  (blue), the Bank of England’s (red) and the ECB’s (green) purchases of securities relative to the respective GDPs . While relying on a single indicator to gauge monetary policies may not be entirely appropriate, the magnitudes involved are quite striking:

  •  the size of the ECB interventions is about one fifth of that of the Fed, about 4% of GDP compared to over 20%

Central Bank Securities Purchases as % of GDP
Central Bank Purchases of Secuiritirs, % of GDP
Source: Gross et al (2011)

In Summary, even assuming very conservative fiscal multipliers, the difference in fiscal stances between the US  and the EUZ (7 points of GDP from peak to trough) goes a long way in accounting for the worse performance of the EUZ compared to theUS (5 point of cumulative growth) even without considering the strikingly less aggressive European monetary policy


Source: P.Manasse calculations on WEO

III. Asymmetries

Beyond the aggregate responses, the crisis has heightened “asymmetries” in Europe. One  example is Italy (red) vs Germany (blu).

  • In 2012, GDP in Italy is  6% below the level of 2006, Germany’s GDP is  8% above 2006,  a difference much larger than that between the US and the EUZ as a whole,

Unfortunately, this pattern is quite general. From the FRED data bank of the St.Louis Fed I took the time series for the American States’ GDPs and I calculated, for each year, the coefficient of variation (the standard deviation normalized by the mean). I did the same for EUZ countries ‘s GDP (data from last WEO) and got the striking picture below (the initial values are normalized to one, click to enlarge).

    Source: P.Manasse calculation on WEO and FRED data
  • Since 2006 the dispersion between EUZ countries’ GDPs rose considerably, by 3%, while that between US States actually fell (-1%)

There are quite a few candidate explations for this:

  • asymmetric shocks:  unlike in the US, countries in EUZ were hit by country-specific shocks (fiscal and current account imbalances in Greece, credit boom and banking crises in Irland and Spain, productivity growth in Portugal and Italy)
  • asymmetric policy responses: unlike the US, in the EUZ we had more fiscal tightening in countries suffering larger shocks;
  • different institutions: unlike the US, EUZ countries have segregated labor markets with different degrees of employment protection and different systems of wage bargaining, different banking and welfare systems, and this  affects the response of the different economies to shocks (this is a long story which I cannor discuss here)

IV. Implications

These recent developments in EUZ have aggravated the “original sins” of the Euro, namely

  • lack of international labour mobility (language, culture, social insurance) leading to unemployment persistence;
  • lack of wage and price flexibility in many EUZ countries;
  • lack of centralized budget i.e absence of a EUZ-wide  insurance scheme (a 1$ decline in income in Texas triggers 40c of extra federal transfers, a 1 Euro decline in income in Spain triggers less than 1c  from Brussels).

This suggest that

  • the reinforced  EUZ’ s national borrowing contraints, introduced in order to contain moral hazard and to prevent (probably unsuccessfully) debt monetization, only impart a recessionary impact on the EUZ: the system lacks any means of dealing with asymmetric shocks.  This is what makes the Euro unsustainable. And it is difficult to immagine that the degree of integration in EUZ labor markets could approach that of the US in the near future;
  • Any form of “political union” without transfers does not help.The problem is that the amounts required are politically unfeasible;
  • Unlike a Banking Union, ESM type of arrangements or, worse Eurobonds, only help to contain the symptoms but not to cure the disease,  which is getting worse.