We got more bad news from Europe last week, and for once it wasn't explicitly about the sovereign debt crisis. Instead the news was more of the run-of-the-mill economic-downturn variety. There were no dramatic press conferences or last-minute deals, but rather just more evidence that a recession is taking hold in Europe.
The slowdown in the eurozone stands in stark contrast to the United States at the moment. The United States is seeing accelerating growth, resilient manufacturing, fairly robust retail sales, an improving job market, and even stabilisation in the long-struggling housing market. So why are things so much worse in Europe right now?
The key new data point this past week was the release of a monthly survey of eurozone purchasing managers. The composite index fell to a three-month low in March as the decline in the broader eurozone economy accelerates. Almost everything the survey measured looked anemic. Hiring is down, new business in both the manufacturing and services sector is declining at a faster rate than that of the last few months, and input costs continued rising. Markit Economics predicts that these numbers mean eurozone gross domestic product is declining at about 0.1%-0.2% from the previous quarter's levels. The downturn is not uniform across the eurozone. Germany is still growing, albeit slowly. France, too, is doing slightly better than average. The real drag on the continent remains the peripheral countries such as Spain and Italy. Even with Germany squeaking by at almost no growth, the overall economic picture on the continent is far from robust.
So why is Europe diverging from other parts of the developed world?
Investment Lacking
The first reason stems from the continued drama of the sovereign debt crisis. One of the major keys to economic growth is investment. As firms decide to invest in their future, the knock-on effect of those long-term purchases helps keep almost all areas of the economy humming along. However, the only way that managers are going to pull the trigger on big purchases is if they expect to receive a reasonable return on that investment over time. This means having the confidence that the economy is going to remain in reasonably good shape in the coming years. It also depends on knowing that the rules of the road are not going to radically change. The debt crisis has not created an atmosphere conducive to confidence. And this lack of confidence also spills over to consumers who are less willing to spend on luxuries in such an environment.
Not slowing down investment and spending was the right decision for many firms and consumers. Political infighting, half-solutions, and a desire to kick the can down the road has left many open questions about the future of the eurozone and the path of future monetary and fiscal policy. If it wasn't clear what currency your nation was going to be using in a year's time, taking out a huge euro-denominated loan might not have been top-of-mind. But even if some individual firms and consumers were making the right call, the pullback in spending has contributed to the decline in growth.
Banks Not Lending
Another knock-on effect from the sovereign debt crisis is how weak it has made the European banking system. Even firms and consumers that wanted to borrow money and invest might have found that the banking system wasn't prepared to lend any money. Instead, banks were saving their capital to help protect against real or potential losses from sovereign debt holdings. The European Central Bank's decision to flood the banks with liquidity by providing almost unlimited three-year loans doesn't seem to have made the banks much more likely to lend. The ECB loans have certainly reduced the risks of bank collapses and have been an important step in the stabilisation of the crisis, but they haven't done much for the real economy yet.
Cutbacks Hurting Growth
Austerity has also had a real impact on the economies of many countries in the eurozone. Big cuts in government spending from the number of government employees to cutbacks in infrastructure spending have created a headwind that makes it harder for the economy to keep growing. New taxes, fees, and other ways to increase revenue have, on the margin, slowed growth across Europe, as well. These steps might be necessary to bring back fiscal balance, but they do so at the cost of near- and medium-term growth.
ECB Not as Aggressive as the US Federal Reserve
Monetary policy might also be a drag on growth in Europe. Unlike the US Federal Reserve which has a dual mandate to keep inflation in check and keep the economy growing, the European Central Bank is only tasked with controlling inflation. So while the Fed has tried many unconventional means of keeping the money supply very loose, the ECB has been much more circumspect. The ECB hasn't gone so far as tightening policy, but it is being less accommodative than its counterpart in Washington.
