Contracting euro zone – Decisive fall to come

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by Judit Kozenkow Ph.D.

August 17, 2012 Washington, DC

After series of signs that the economic situation in Europe has been rather worsening than improving recently, here came the next bad news: the economy of the euro zone contracted in the second quarter of this year.

Eurostat, the European Union’s statistics agency reported on Tuesday that gross domestic product (GDP) in the euro zone and even in the whole European Union fell by 0.2 percent during the second quarter of 2012 compared with the previous quarter. In the first quarter growth rates were zero. Also if we take a look at the European data compared with the previous year the results are even worse: 0.4 percent contraction, while GDP in the U.S. rose by 2.2 percent compared with the same quarter of the previous year. (Source: Eurostat)

This time the slowing growth in Germany and the positive growth rates of Austria, Estonia, the Netherlands and Slovakia as well as the stagnation in France did not prove to be sufficient to keep the euro zone at least the previously experienced level – at a zero rate. Negative rates varied between -1.2 (in Portugal) and -0.4 (in Spain). So where is Europe heading?

Taking into account the usual economic slowdown for summer it is likely that the euro zone is falling into recession with a potential negative growth rate for the third quarter of this year.

Further weakening of the euro is also highly possible – that has been frequently mentioned as an export promoting feature now it seems to be weakening and more and more overshadowed by a potential chaotic Greek exit as well as the lack of trust in the euro zone markets after a long period of muddling-through policies of the political leaders. The belief that the euro is unbreakable is still holding the field among international investors but the question is: how long? And how long can be Europe still considered as central part of the world economy or could it slip to the periphery with its major problems on its periphery?

The Economist described the problem: “Southern Europe’s economic rot is deepening and spreading north.” After the summer break it is essential for the European leaders to find solutions to turn up in the short run. Besides necessary long-term and comprehensive actions, dynamic steps are needed to recover from the upcoming recession and avoid a total lack of investor confidence in the European markets.

Ahead of the G8 summit meeting in May German Chancellor, Angela Merkel agreed that fiscal consolidation and growth are both needed. According to macroeconomic studies fiscal consolidation could have only limited growth effects. Maybe it is high time to take one step further and instead of talking about fiscal consolidation and growth let’s change the order and concentrate on growth in the short term. Right now best practice would be not to push the economies deeper into recession but to create growth and complement national macroeconomic policies at the European level.

Repairing the financial sector, building a stronger financial safety net and restructuring the labor markets could be the basic elements to promote economic growth. The decision on ‘make-it or break-it’ is mainly in the hands of Germany. We will see it soon what direction the euro zone is heading.

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