If you look for them, you can find reasons for optimism in the European Commission’s economic forecasts published last week. While Europe is back in recession because of renewed lockdowns, last year turned out better than expected. With improved growth prospects from the end of this year, the EU will recoup its pandemic output losses by mid-2022, earlier than previously thought.
But looking for optimism would be to miss the most important finding in the forecast, which is that the bloc’s economic output will remain significantly below the pre-pandemic trend. Some economies — Spain and Italy — will still not have recovered their end-2019 national income levels by the end of next year.
In other words, Brussels at present expects the EU to suffer economically from the pandemic long after the health threat itself is (hopefully) beaten back and lockdowns are lifted. Political leaders should not allow that to happen. Instead, they must aim to outperform the forecasts with more aggressive policy action than currently foreseen.
That means, above all, to give the recovery as much fiscal support as possible. Governments have by and large done an admirable job of supporting their economies so far. The point of danger will come as growth picks up in earnest from the middle of the year, when vaccination programmes will be sufficiently complete for most restrictions on activity to be lifted.
At that point, governments will rightly phase out the income support packages that have kept businesses and households afloat. The risk is that this will pull too much demand out of the economy and jeopardise the recovery. According to IMF projections, many economies including Germany, Spain and the Netherlands are set for massive structural fiscal tightenings this year.
This may not doom the recovery: pent-up consumption desires and post-pandemic optimism could boost private demand more than enough to offset public-sector retrenchment. But that hope is a shaky basis for policy. The risks that threaten to hold back private demand are too great and numerous.
Among them is the large number of troubled companies whose day of reckoning has been postponed by cheap loans and suspended bankruptcy procedures. Soon enough, corporate debt overhangs and a potential wave of business failures will curtail the private sector’s ability to bounce back.
Another risk is that optimism and confidence fail to materialise. The extraordinary changes that have turned our lives and livelihoods upside down could lead people to save more of their incomes than before out of precaution.
Then there is “hysteresis”: the tendency of the economy’s permanent capacity to shrink if it is not fully utilised for too long. These are different problems that require different policy solutions. But they would all be moderated by forceful fiscal stimulus. That is why it is precisely when income support is phased out that more conventional fiscal stimulus must take its place.
Europe should learn from Joe Biden, who has decided that the risk of doing too little outweighs that of doing too much. Perversely, the US president’s fiscal package has come under friendly fire from luminaries such as Lawrence Summers and Olivier Blanchard, who worry it will overheat the economy.
In fact, overheating is both unlikely and would be a nice problem to have. “Excessive” growth would automatically scale down the proposed fiscal response — some of which takes the form of extended unemployment benefits. And the last few pre-pandemic years proved that sustained high demand pressure, far from causing inflation, could instead reverse the long decline in US labour force participation.
It would be tragic if scepticism in the US strengthened doubts about a punchy fiscal stimulus in Europe, which needs one at least as much. This will not come from the pan-EU recovery package, which is dwarfed in size by national budgets. Brussels expects its “recovery and resilience” money to boost Europe’s economies by up to 2 per cent of gross domestic product, and more in less well-off areas. But the necessary extra boost must come from governments letting loose their greater fiscal firepower.
Removing national inhibitions against more deficit spending could, economically speaking, be the most important contribution EU money makes. The bloc must also without delay extend the suspension of the regular fiscal rules, which are otherwise set to expire at the end of this year.
Americans have the luck to be governed by a president who has learnt the lesson of the previous crisis. Time to show Europeans that this luck can be theirs, too.