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 Analysis: Growth to bear brunt of euro crisis cure

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PostSubject: Analysis: Growth to bear brunt of euro crisis cure   Tue Dec 13, 2011 4:29 pm

LONDON (Reuters) - Europe's economic prospects next year are so bleak that 2011, for all the euro's agonies, has every chance of being remembered fondly.
In forging a fiscal compact that aims to put the single currency on a firmer long-term footing, euro zone leaders have set the 17-nation bloc on course for prolonged austerity.




Given powerhouse Germany's
insistence on budgetary rigor, policy tightening that reinforces the
cyclical downturn was politically predictable. And given the unforgiving
mood of the bond markets, such an outcome was perhaps unavoidable.
Still,
in the eyes of a number of economists, the euro zone's policy settings
risk making the process of whittling down debt tougher than it needs to
be.
First, because pro-growth reforms are playing second fiddle to
rapid deficit-cutting; and second, because debtor/deficit countries on
the euro zone periphery are being asked to bear a greater burden than
creditor/surplus countries in correcting the current account imbalances
that are at the heart of the single currency's existential crisis.
"It's
been clear for some time that the stronger north Europeans, led by
Germany, need to stop tightening their economic policies and adopt at
least mildly expansionary policies," said Fred Bergsten, director of the Peterson Institute for International Economics, a think tank in Washington.
In addition, Bergsten said he was convinced that the European Central Bank
(ECB) would quickly follow up last week's quarter-point cut in its main
short-term interest rate with two more quarter-point reductions.
"In
the public discussions, there's been an excessive weighting to
austerity," Bergsten told reporters in a conference call. "If Europe
goes into a deep recession, that obviously makes the adjustment program
more difficult to carry out, both in economic and political terms, so
the Europeans need to add a pro-growth dimension to the financial
engineering that has been the focus of their activity so far."
DUTCH SLOWDOWN
Underlining
the speed of the deterioration in the economic outlook, a leading Dutch
think tank forecast on Tuesday that the economy would shrink 0.5
percent next year. As recently as mid-September, the Netherlands' Bureau for Economic Policy Analysis (CPB), which advises the cabinet, had projected 1.0 percent growth for 2012.
And
underscoring how an economic downturn wreaks havoc with public
finances, the CPB revised up its forecast of the 2012 Dutch budget
deficit from 2.9 percent of GDP to 4.6 percent -- above the 3 percent
limit that the euro zone's leaders vowed last week to respect on pain of
quasi-automatic sanctions.
For Dario Perkins, an economist at Lombard Street Research, a consultancy in London, the belt-tightening prescribed by Germany and its ally France is the wrong solution to the euro crisis. Spain and Ireland, now deeply indebted, would have comfortably met the new fiscal rules before the 2008 recession.
Nor does the fiscal pact address future imbalances in the euro zone and the flow of debts they imply, Perkins said in a report.
"Deep
structural, competitiveness and trade imbalances remain. Austerity does
nothing to improve these, except via the unintended route of
encouraging depression and deflation," Perkins wrote.
Indeed, austerity merely compounds economic weakness, leading to further austerity. "Greece
has neatly illustrated this and it's hard to see how rolling this same
policy out for a wider set of other European economies could lead to a
more favorable outcome," he said.
STRUCTURAL SLOG
In a sign Germany expects a sharp slowdown, Chancellor Angela Merkel
said on Tuesday that the euro zone needed growth as well as budget
discipline. Smart energy grids and rural broadband networks were two
areas where investment could give a lift to the economy.
But for
Germany the main route back to growth lies through structural reforms
that address an economy's underlying shortcomings such as inadequate
education levels and rigid labor laws. By their very nature, deep-seated
changes to the very fabric of a society are a long-term undertaking.
"This takes years. You don't raise the quality of human capital in three years," said Antonio Garcia Pascual, an economist at Barclays Capital in London.
One
way to narrow the debtor/creditor competitiveness gap would be to bring
about a depreciation in the real exchange rate of weaker countries by
engineering a big shift in relative inflation rates, noted Bank of Canada Governor Mark Carney.
In short, Germany would be asked to put aside its visceral fear of inflation for the good of euro zone balance.
"However,
it is not clear that ongoing deflation in the periphery and higher
inflation in the core would prove any more tolerable than it did between
the United Kingdom and the United States under the postwar gold standard of the 1920s and 1930s," Carney said in Toronto on Monday.
With
no alternative short-term adjustment path available to Europe, Carney
said the combination of fiscal austerity and structural change would
mean falling wages, high unemployment and tight credit.
"A
sustained process of relative wage adjustment will be necessary,
implying large declines in living standards for a period in up to
one-third of the euro area," he said.
Will bond investors and
voters buy into a strategy of prolonged stagnation? Perkins with Lombard
Street Research is skeptical. A failed auction or weak economic data
could trigger significant market volatility, forcing policymakers into
radical measures, he argued.
"If the Germans and French really see
fiscal union as the only solution, they have to be prepared to pay for
it. If they won't pay, the ECB will have to. More likely, some countries
will eventually realize the futility of the austerity death-spiral and
decide to leave the euro area," he wrote.


Source:

Reuters US Online Report Top News
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