Europe Shuns US-Style Stimulus Steps
For much of the past year, many economists and investors expected the U.S. to fall into recession, while it appeared much of Europe might avoid one. That hasn’t happened. Growth in the 15 countries that share the euro currency contracted in the second quarter, the first contraction since the early 1990s. A big part of the problem is the fallout from financial turmoil that began with U.S. mortgage-related securities.
The U.S. economy meanwhile surged by an annualized 3.3% in the second quarter, buoyed by government intervention and a weak dollar that spurred export growth.
The prospect of recession — generally defined as two consecutive quarters of declining economic output — prompted the Federal Reserve to slash interest rates and Congress to pass a $168 billion stimulus package. Most economists say those actions helped cushion the blows from a housing bust, credit crunch and skyrocketing energy prices.
But institutional and cultural constraints make it hard for Europe to try something similar. The European Central Bank has a single mandate to keep prices steady — a legacy it inherited from Germany’s central bank, which was determined to avoid a repeat of the hyperinflation of the 1920s. The U.S. Federal Reserve, by contrast, is responsible both for supporting growth and controlling inflation.
Euro-zone countries also agree to adhere to fiscal rules that limit budget deficits to 3% of gross domestic product. While the rules discourage big debt buildups, they also limit policy makers’ scope to stoke growth with tax cuts or rebates.
‘The world’s been hit by massive shocks, so everyone should slow down,’ said Erik Nielsen, an economist with Goldman Sachs in London. ‘But the U.S. has absolutely thrown the kitchen sink at the problem.’
Dismal European growth forecasts Wednesday underscored the rising recession risk. Quarterly economic forecasts from the European Commission project annual euro-zone growth this year at 1.3%, half its 2007 rate and below April forecasts of 1.7%. Outright recessions in Germany and Spain, coupled with stagnation in France and Italy, will bring third-quarter economic growth across the bloc to a standstill, according to the forecasts. The U.K., which doesn’t use the euro, will also see a recession starting in the third quarter, the forecasts say, as a collapsing housing market continues to damp consumption and investment.
Luxembourg Prime Minister Jean-Claude Juncker, who leads a committee of euro-zone finance ministers, said the bloc could see a ‘technical recession’ and called the situation ‘serious.’European Central Bank President Jean-Claude Trichet declined to forecast a recession. He reiterated that the central bank expects the bloc’s economy to bottom out this year before staging a gradual recovery. Tackling inflation, which at 3.8% in August was well above the central bank’s preferred range of just below 2%, remains policy makers’ priority because they believe rising prices threaten longer-term growth.
A euro-zone recession would make it harder for the U.S. economy to keep expanding. Before the euro-zone economy started stumbling, it was boosting sales growth and profits for U.S. and Asian companies. The weak dollar has boosted U.S. exports to Europe.
The U.S. economy contracted slightly in the fourth quarter of 2007 and barely grew in the first three months of this year. The Fed has cut interest rates to 2% from 5.25% a year ago, and isn’t likely to increase rates until sometime next year despite concerns about inflation. Democrats are pushing a $50 billion stimulus package in Congress. Democratic presidential nominee Barack Obama is urging one that is twice as large. Republican standard-bearer John McCain hasn’t signed on, but he is pushing a big reduction in corporate taxes.
In Europe, monetary policy makers remain focused on inflation. ECB policy makers raised their key rate to a seven-year high of 4.25% in July. ECB watchers predict inflation fears will keep the ECB on hold through year-end before softening growth pushes policy makers into interest-rate cuts in the middle of next year.
Spain, which is suffering a steep slowdown as a decade-long housing bubble bursts, has broken the European mold by embarking on a U.S.-style stimulus program. Prime Minister Jose Luis Rodriguez Zapatero Wednesday pledged an additional 3 billion euros ($4.23 billion) in public financing to help home builders refinance existing loans.
Joellen Perry / Sudeep Reddy