Can Europe survive a US slowdown

Yesterday the European Commission published its latest economic forecasts; they were pretty upbeat:

Economic growth is speeding up this year to 2.7% in the European Union and 2.5% in the euro area, driven mainly by domestic demand, particularly investment. This is the strongest growth since 2000.

...“Economic growth this year is set to be the best we have had since 2000. Let’s use these good times to press ahead with further structural reforms and budgetary consolidation. Only this way will we be able to increase the growth potential where it is low and manage the necessary safety margin for when the going gets rough”, said Joaquín Almunia, the Economic and Monetary Affairs Commissioner

Meanwhile, to celebrate it's third anniversary, European blog A Fistful of Euros is running a series of guest posts. Yesterday Mark Thoma of Economist's View asked: Is Trichet’s Optimism Justified? It's a long post, packed with quotes, but essentially Mark asks whether Europe can survive a US economic slowdown. He also discusses whether strong growth in the rest of the world could bail the US economy, and what help a weaker US dollar might be. He concludes:

So where does this leave us? Should a slowdown in housing occur in the U.S., I am not confident that offsetting changes in aggregate demand from other sectors, the foreign sector in particular through changing imports an exports, will be sufficient to offset the decline. And should a decline occur, it stands a good chance of spreading to Europe and Asia causing further problems for all U.S., European, and Asian economies.

Returning to the the original question, should Trichet be optimistic that Europe can weather a U.S. slowdown? I believe there is reason for be wary. Given the long lag between the time that interest rates are changed and the the response of inflation, output, and other macroeconomic variables, if I were in Trichet’s shoes, I would think hard about holding interest rates steady for now and waiting to see how events unfold. The rise in inflation and inflationary expectations and the relatively accommodative stance for interest rates make that strategy hard to pursue, but it’s still worthy of serious onsideration.

Edward Hugh's comments on the post are also worth reading.

Comments

[A. PERLA]

EU Commission: "Economic growth this year is set to be the best we have had since 2000. Let’s use these good times to press ahead with further structural reforms and budgetary consolidation."

Let's hope they translated that bit into French and German. ; ^ )

[A. PERLA]

Thoma: "if I were in Trichet’s shoes, I would think hard about holding interest rates steady for now and waiting to see how events unfold. The rise in inflation and inflationary expectations and the relatively accommodative stance for interest rates make that strategy hard to pursue, but it’s still worthy of serious onsideration."

Yes, well, Trichet might be doing just that.

What he is looking for, I suspect, is the kindling of durable domestic demand in France and Germany (Italy and Spain would help, but Trichet is no fool either). France responded finally with first half annual GDP rise of promising proportions after only a decade in the economic doldrums). There is a scintilla of hope that Germany might respond as well.

What is the key to domestic demand? Consumer spending. What keeps consumer's from spending? Inflation. They demonstrate far, far les discretionary spending and save their money for essentials (which they know will increase in price.)

Some of these essentials are previously stable commodities, such as bread and (even) gas or water. They are all rising, since the third quarter (just after summer) is when companies traditionally sock price rises to customers.

A bit more patience is required. The prime objective of the ECB is to control inflation. The past has taught us too well the wisdom of that rule.

NB: And, of course, the corollary to the above is increased productivity from existing manpower levels. Mounds and mounds of technology-sparked productivity can be employed in the Euro-area, but companies are presently obtaining more productivity out of labor by extending hours worked (for the same pay) rather than introducing technology. This first, to tame the unions, then on to technology-induced productivity gains.

[Edward Hugh]

"Edward Hugh's comments on the post are also worth reading."

Thanks for the plug. Keep up the good work here.