March 2013

INSIDE VIEW: Policy direction: US v eurozone

BankThe absence of federalism in the eurozone is hindering its post-crisis recovery. Patrick Artus, of Natixis, compares the economic policies of the US and the eurozone, to see why America is now in a favourable economic position.

Over the past several years it has become increasingly clear that the US has managed its economic situation better than the eurozone.

Indeed, many member countries of the single currency area are still mired in recession four years after the onset of the financial crisis. The US, however, is experiencing an upturn in growth, a recovery in business investment and significant deleveraging by the private sector. There has also been an upswing in stock market prices and a recovery in consumption.

Although the economic crisis was no less severe in the US than in the eurozone, it has been America’s recovery methods – in terms of policy – that has set it apart from the still-struggling eurozone. In fact, it’s the absence of a federal structure in the eurozone that has had serious consequences on how its economy has been managed.

At the outset, the global financial crisis was an American crisis. It can be traced back to the 2007 bursting of the real estate bubble in the US, when a contraction in residential prices led to a massive increase in borrower defaults and a meltdown of property-related asset prices. Further, the banking crisis – that resulted in the bankruptcy of Lehman Brothers and the meltdown in construction activity – also set the crisis in motion across the globe.

There are a number of catalysts that made it too easy for these serious dilemmas to spread to the eurozone. There was the banking liquidity crisis (which occurred because of the seizure of interbank markets); a contraction in global trade (because of the freezing of export credit); the beginning of the real-estate crisis (a direct consequence of the banking crisis); and the excessively-large household debt in certain countries (Spain and Ireland).

Two policies have played a role in shaping the correct response to fix these economies. It just so happens that the US. has been better placed – in both instances – to reap the intended benefits.

Monetary policies: of course, monetary creation has been just as great in the eurozone as in the US. Yet America’s monetary policy has led to long-term interest rates dropping to a markedly lower level than the growth rate, which explains the recovery in asset prices, the significant level of deleveraging and the upswing in demand in the US. Unfortunately, the opposite is true in the eurozone.

Fiscal policies: political compromises have been made in the US to gradually reduce the fiscal deficit, as opposed to setting up a rapid reduction. Indeed, although the process was somewhat chaotic, we saw this policy direction in the eventual consensus over the “fiscal cliff” negotiations.

The eurozone, on the other hand, has gone down a different route. They decided to rapidly slash the fiscal deficit in all the countries where it’s too high. This has led to a severe contraction in activity, preventing any swift improvement in public finances.

In this respect, the fact there is no federal structure in the eurozone has had serious consequences on how the economy has been managed. Indeed, the focus of fiscal deficit tends to be put on individual countries’ situations, rather than the region as a whole.

Certainly, the eurozone is struggling to recover, when compared with the US. And the lack of federalism in the eurozone – and, therefore, the discord between member countries – must take some of the blame.

The segmentation of capital markets across Europe makes it difficult for the European Central Bank (ECB) to reduce interest rates on government bonds, as it buys the government bonds of every troubled country individually. Meanwhile, in the US, there is only one public debt.

The ECB is also alarmed by the risk of “moral hazard”. The concern that purchasing a country’s debt might lead it to halt its attempts at improving its public finances. Indeed, as countries enjoy fiscal sovereignty, implementing credible fiscal discipline remains difficult, which undermines confidence.

This lack of federalism means that the fiscal deficit of each country is a concern. It also means conducting restrictive fiscal policies in countries posting substantial deficits.

However, if the eurozone was a federal state, attention would be focused on the region’s average fiscal deficit instead. And this would mean that a rapid reduction of the overall fiscal deficit would not be required, because – collectively – the deficit would not seem so alarming.

Patrick Artus is chief global economist at Natixis

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