World Economics - Insight , Analysis and Data

World Economics - Insight , Analysis and Data
The Economic Future of Europe
Jan Libich
World Economics, December 2014

What does the economic future hold for Europe? In the aftermath of the 2008 crisis, four macroeconomic threats have been subject to heated debates by economists and politicians. Some fear that Europe may face (1) secular stagnation, (2) sovereign defaults, (3) excessively high (or low) inflation and (4) collapse of the common currency euro. This paper discusses the relevance and potential drivers of these four threats. Importantly, it highlights the relationships between them, offering an analogy between the European economy and an overweight patient suffering from diabetes. The discussion implies that Europe needs long-term austerity but short-term stimulus, precisely the opposite of what most European countries have done since 2010. In particular, the paper stresses the need for conceptual reforms of public finances that take into account the ageing population trend, especially the pay-as-you-go financed pension and health care schemes. It is argued that such reforms would not only decrease the risk of costly sovereign defaults, but also reduce uncertainty in the economy, stimulate economic activity, and thus minimise the risk of a secular stagnation and a deflationary trap in the aftermath of the 2008 crisis. In addition, they would decrease the likelihood of excessive inflation further down the track caused by unpleasant monetarist arithmetic, as well as reduce the danger of a euro breakup. This scenario parallels an overweight patient adopting a suitable diet that helps him reduce his weight, blood pressure and insulin dependence – alleviating the risk of premature death.


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