Voices calling for the disintegration of Europe appear to be growing louder. In fact, there is plenty of evidence that good news is starting to drown out the bad.
Britain is preparing to trigger Article 50 of the Lisbon treaty, formally beginning the EU exit process. Anti-euro candidates are taking a high profile in the Netherlands, France and Germany ahead of forthcoming elections. Italy’s banking sector is being kept alive, but only thanks to monetary injections. Tensions between Greece and its creditors have flared again.
It would be easy to lose faith in Europe. Yet below the surface, the economic outlook is, on balance, positive. The latest economic data and indicators on consumer and business confidence are encouraging across most of the euro area. For the first time in almost a decade the European Commission is predicting GDP growth for all EU member states throughout its entire forecasting period to 2018. This would build on solid output expansion of 2% in 2015 and 1.8% in 2016.
Part of the recovery has been propelled by the European Central Bank’s accommodative monetary policy stance. Through low interest rates and its asset purchase programme, the ECB has helped sustain investment sentiment and boosted the euro area’s export performance through weakening the currency.
However, the benefits have mainly been concentrated in the financial system and have largely failed to spread to the real economy. So far, a high level of non-performing loans and tightening regulation have constrained the ability of banks to transmit credit to businesses and consumers. But banks’ efforts to raise capital in the post-crisis period are now starting to have a positive impact on lending. This is important for the real economy given the euro area’s bank-centric environment. And while the ECB is expected to normalise policy this year, this is likely to be implemented gradually given the need to avoid a banking crisis in Italy. Moreover, the form that normalisation takes matters. Raising deposit rates would help bank profitability and could have positive effects.
Even the politics are not as scary as they first appear. A legacy of generous welfare policies means that inequality is lower in the euro area compared with the Anglo-Saxon world, where we saw a surge in populism in the form of Brexit and the election of Donald Trump. The Gini coefficient, a popular measure of inequality, is 0.40 in the US and 0.36 in the UK, but below 0.30 in the Netherlands, France and Germany according to data from the Organisation for Economic Co-operation and Development.
On the specific danger of escalation of the Greek debt crisis, incentives among all key parties are ultimately aligned on avoiding a repeat of the summer of 2015 when the risk of ‘Grexit’ was highest. European creditors are trying to avoid the Greek debt crisis being the main item on the agenda during election season. Alexis Tsipras, the Greek prime minister, would likewise prefer to avoid elections, knowing that he is behind the opposition in the polls.
The most probable scenario is that Greece accepts to legislate some additional measures now, such as lowering the income-tax free threshold, in return for the promise of conditional debt restructuring. Such an agreement could have important positive effects on the economy. The Greek stock market rallied on a 17 February news story by German newspaper Der Spiegel that the International Monetary Fund would participate in the Greek bail-out with €5bn, before falling back as the Fund refused to confirm reports. Beyond the short-term sentiment boost, a completion of the second review of the third bail-out would pave the way for Greece to be included in the ECB’s quantitative easing programme.
As for the risk of a Marine Le Pen victory in France, the particularities of the French election system, the tradition of high voter turnout in the second round, and the reliability of opinion polls given the long presence of her National Front in elections are all factors pointing to a very low probability of her winning. Instead, a victory for Emmanuel Macron could provide an impetus for closer pro-reform Franco-German efforts, irrespective of whether it is Chancellor Angela Merkel or her rival, Martin Schulz, that leads the coalition in Germany.
Danae Kyriakopoulou is Head of Research at OMFIF.