Myth of the European Economy

Contrary to much of the rhetoric in the mainstream media, the recently heralded “recovery” in Europe is at best a lazy, short-sighted analysis of the current situation. Such a narrative seems to have been formulated solely from citing one quarter’s rise in the GDP of the “Euro zone” aggregate whilst overlooking the ever growing divergence amongst the member countries of the currency bloc.


To labour the point, one observes from the above chart the meaningless Euro zone average (in red) whilst noting the widening macroeconomic performance between the selected periphery and core countries.

Many commentators and officials point to the adjustment of the external balance in the periphery highlighting its improved competitiveness, often labeling this a recovery. But this conveniently ignores the underlying malaises that are driving these dynamics such as collapsing domestic demand, not to mention the vastly divergent fortunes between different countries in the Euro zone.

Change in the volume of domestic demand


Euro area












Source: AMECO, European Commission

Again, it is pretty obvious that drawing any conclusions from the Euro- area average isn’t particularly useful with regards to explaining what may or may not be occurring in the “European economy”. Nevertheless, a similar theme can be found in the ECB’s analysis. Their latest bank lending survey made no reference to any actual member countries, only various Euro area aggregates, something I found mildly amusing.

With this in mind, looking closer at the much proclaimed credit crunch in Europe, the following exposes the problem with such analysis. There have been growing calls for the ECB to act to support lending as the most recent data showed loans to the Euro-area private sector contracting 1.9% YoY in September. But again there is an uneven picture across the monetary union which puts the usefulness of the aggregate number into question.

Whilst issues persist in Spain and Italy (and elsewhere), the same cannot be said of Germany where would appear to be little justification for an ECB intervention.

The next claim is that a persistently high exchange rate, perhaps driven by a growing current account surplus, will lead to inflation in Europe undershooting the ECB’s target. Yet even if one ignores the growing gap between the German surplus and French deficit, it is difficult to imagine why the ECB would want to use the aggregate inflation rate when there is such variation between countries.

Evidently, it would appear slightly ludicrous that a single monetary policy would be suitable for both Greece and Estonia. Yet, even more absurd would be setting a common policy based on so called “Euro-area inflation” given the variations that clearly exist. But apparently this is the case.

And finally, a recent piece by think tank Bruegel really hit the nail on the head when they revealed the true extent of the economic absurdity that is the single currency. Their ‘Taylor-rule’ analysis showed that, despite a suitable “Euro area” aggregate interest rate of about 0.5%, it needs to be about 4% in Germany and -15% in Greece!

I could continue providing many more examples but you get the point. The logic that follows is that it cannot be suitable to analyse events in Europe as though there is a single economy or worse, a single country, as much of the mainstream media currently does. Whilst the Euro zone shares a common currency, this does not mean that the member countries also have many, or indeed any, shared macroeconomic characteristics.