Economic slowdown hits euro zone in worse shape than the USA

The global economy is severely impacted by various factors in the summer of 2022. Many countries are on the brink of recession. The Corona lockdowns in China and, from a European perspective, the war in Ukraine in particular, are reducing growth in many places, fueling inflation and bringing the euro zone in particular, but also the United States, to the brink of recession. The Chinese economy is also likely to show low growth rates this year and will not be able to act as an economic locomotive. After the financial crisis, Chinese stimulus programs were stimulating the global economy.

In the first half of 2022, economic output in many countries was already only moderate or even declining. The US economy, for example, contracted by 1.6 and 0.9 percent in the first two quarters of 2022 (annualized). The purchasing managers’ indices and consumer sentiment also point to subdued growth in the summer half-year. In addition, monetary policy is rapidly becoming more restrictive in view of high inflation on both sides of the Atlantic.

In the euro zone, the economy grew by 0.6 percent in the first quarter. However, this was primarily due to still strong export growth and a high inventory build-up. However, private consumption and investment have already declined somewhat. In the euro zone, too, in view of the depressed assessment of the economic situation and outlook among both companies and consumers, only stagnation is to be expected in the summer half-year. The global economy continues to be severely impacted by the war in Ukraine and the Chinese corona crisis. Recently, in particular, concerns about an impending gas shortage and even higher energy prices have increased noticeably again. These developments are also contributing to inflation remaining high. In addition, the export industry is suffering from the weak global economy. At present, the order backlog is still high. However, it can only be processed slowly because global supply chains are still disrupted and the shortage of starting products remains serious in many places. Although there are signs of a gradual easing in supply chains, the war in Ukraine and the lockdowns in China will probably continue to contribute to increased problems in the coming months. Supporting the economy, at least for the time being, are still the services, which are benefiting from the easing of the Corona protection measures. Tourism and the food service industry in particular are enjoying a good start to the summer. However, this recovery process is now gradually coming to an end. In addition, high inflation is significantly reducing household purchasing power, which is contributing to a marked deterioration in consumer sentiment.

Somewhat later than the U.S. Federal Reserve, the European Central Bank (ECB) raised its key interest rates in July to counter high inflation and dampen inflation expectations. In addition, the securities purchase program was ended in June. The increasingly restrictive monetary policy will further dampen the already weak economic growth and, together with the consequences of the war in Ukraine and the corona crisis in China, will probably lead to a slight decline in economic output in some euro area countries.

Looming recession hits euro area at an inopportune time

The growth freeze is hitting the euro area economies in worse shape than that of the United States. The U.S. economy digested the pandemic-induced slump in spring 2020 more quickly than the euro area. For example, the U.S. economy regained its pre-crisis GDP level of late 2019 as early as early summer 2021, whereas this was not the case for the euro area until about a year later.

An important reason for the rapid recovery in the United States is probably the extremely expansionary fiscal policy during the pandemic. In total, three fiscal packages amounting to nearly 15 percent of U.S. gross domestic product were passed in 2020 and 2021 under Presidents Trump and Biden. These fiscal packages have stimulated private consumption. In the euro area, by contrast, private consumption has not yet reached pre-crisis levels even at the beginning of 2022.

Even from the last major economic crisis – the financial crisis which originated in 2007/2008 – the US economy recovered more quickly than the euro zone. This is also due to the debt crisis that started in several euro area countries at the beginning of the last decade. As a result, economic output in the United States increased by around 25 percent between 2008 and 2021, while gross domestic product in the euro area increased by only 12 percent. In particular, the debt crisis in some euro area countries has widened the growth gap between the two economic areas.

Not only has economic output and private consumption developed significantly better in the USA than in the euro area, but so has investment in equipment – in other words, those key investments that are of great importance for long-term economic development. Looking at the entire period since 2008, equipment investment in the euro area has increased only marginally, while in the USA it has risen by more than 50 percent. Equipment investment in the euro area has also not yet fully recovered from the pandemic, while in the USA it was already well above pre-crisis levels by the beginning of 2021. The subdued investment trend is reducing growth prospects in the euro zone. At the same time, there is a high need for investment in Europe, particularly to successfully shape the energy transition and digitization. At least there is reason to hope that the “Next Generation EU” instrument will provide some impetus for investment in the euro area in the coming years.

Also important for long-term economic development are investments in research and development as well as software, which are part of intellectual property products in the national accounts. However, the data should be interpreted with some caution, as these are difficult to determine due to their intangible nature, among other things. After all, the development in the euro area was for a long time similarly dynamic as in the USA. In both economic areas, these investments have increased by around 70 percent since the financial crisis. Since the pandemic, however, a clear gap seems to have opened up between the United States and the euro area, according to the official figures. While the United States appears to be experiencing a boom in these intangible investments, they have plummeted noticeably in the euro area.

So even before the outbreak of the war in Ukraine, the euro area had already fallen further behind in growth during the pandemic. In this respect, it is also helpful to compare the forecasts for 2020 and 2021 made by the International Monetary Fund at the end of the year with actual developments. This comparison suggests that economic output in the United States in 2021 was only slightly more than one percent below the level assumed at the end of 2019. In the case of the euro area, on the other hand, there was still a gap of more than four percent.

Various scenarios conceivable for the coming economic development

Before the outbreak of the war in Ukraine, it could be assumed that the U.S. economy would achieve the growth path assumed by the International Monetary Fund at the end of 2019 in the current year. For the euro area, on the other hand, the International Monetary Fund assumed in January 2022 that the growth trend expected before the pandemic would still not be achieved in 2024 and that a prosperity gap of just over one percent of gross domestic product would probably remain. 

The war in Ukraine, which is a tragedy for the people affected, is now leading the global economy into a second crisis shortly after the pandemic. Similar to the debt crisis after the financial crisis, the war is now likely to put the brakes on economic recovery. In the further course, only low positive or even negative growth rates are to be expected in the developed economies. The headwinds are blowing too hard: Inflation, war in Ukraine and lockdowns in China all continue to weigh on economic development. Added to this is a monetary policy that is rapidly becoming more restrictive in the face of inflation. The US Federal Reserve and the ECB will continue to raise interest rates rapidly and make their monetary policies more restrictive.

As with the debt crisis ten years ago, the euro area is economically more affected by the war in Ukraine than the United States for obvious reasons. The growth gap with the United States is thus likely to widen further. An important difference to the debt crisis in the euro area today, however, is that the German economy is no longer the driving force in economic growth, but is one of the laggards, mainly due to its high energy dependence on Russia to date.

Two scenarios illustrate an approximate order of magnitude for the widening growth gap between the USA and Europe up to 2024, assuming further developments in GDP up to 2024 for the USA and the euro zone by means of a positive and a negative scenario for each (Fig. 4). These scenarios are not to be understood as complete forecasts, but are intended to illustrate how economic output could develop under the respective scenario. In the positive scenario, it is assumed that the central banks of the USA and the euro area succeed in controlling inflation with a more restrictive monetary policy in such a way that no recession occurs. In addition, it is assumed that the conflict in Ukraine will continue but that there will be no sudden halt in gas supplies to Europe. The negative scenario, on the other hand, assumes that the central banks will have to tighten the monetary reins to such an extent that a recession with a weak recovery will result. In addition, there will be a halt to gas supplies to Europe in the fall of 2022.

Even in a positive scenario, the GDP growth assumed at the end of 2019 will still not be achieved in the USA in 2024, leaving a gap of around one percent of GDP (Fig. 4). In the case of the euro zone, on the other hand, gaps of almost three percent will remain even in the positive scenario. A gap of a similar size would only arise for the United States in the negative scenario. By contrast, in this negative scenario, gaps of almost five percent will remain in the euro area in 2024. The pandemic and the ensuing war would then result in long-lasting losses in prosperity – also due to the triggered high inflation and monetary tightening.

I published an earlier version of this text on June 30.


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