The intensity of the EU's next recession will not be comparable to the previous one that occurred a decade ago



A trader puts his hand to his face while working on the floor of the New York Stock Exchange in New York November 1, 2007. The financial sector dragged down the stock market on Thursday, wiping out the previous session's Fed-fueled gains, after brokerages downgraded the two largest U.S. banks, renewing fears of more fallout from the credit crisis. REUTERS/Shannon Stapleton (UNITED STATES) - GM1DWMRXMAAA
Shannon Stapleton / REUTERS

Ilustration: New York Stock Exchange, November 1, 2007

Economic growth in most European countries has been slowing down lately, just like in other parts of the world (from China to USA).

Even though the phase of economic expansion in some countries lasts for almost 10 years now, we remember all-to-well the impact that the Great recession of 2007 had, so a question about the prospect of a new recession has been frequently asked.

It should not be surprising that numerous scholars claim that the next recession will have equal, if not worse, consequences than the previous one. However, we should analyse the macroeconomic indicators which those statements are based upon.

First and foremost, one should bear in mind that the economic crisis, which in EU started in 2008, did not have the same impact on all European countries. In some Member States (i.e. Sweden, Germany, Belgium, and France) it took only several quarters to match the pre-crisis level of GDP, while other Member States have not succeeded in that task even 10 years after the turmoil (i.e. Greece and Italy).

The main reason for such development is structural: some economies have recorded decline only as a by-product of the outer shock (global financial crisis followed by the huge oil price growth), so those economies have, consequently, manage to recover quickly. On the other hand, most of the European economies had excessive macroeconomic imbalances and unhealthy structure of economic growth for years prior to the Great recession of 2007, so those economies were forced to go through the 'valley of tears' in search for new and more sustainable forms of growth.

Macroeconomic imbalances might be most obvious when one observes the current account balance of each individual country. In that sense, Belgium, Germany, Sweden, the Netherlands, and France have been continuously recording a trade surplus, while other EU countries have been struggling with enormous current account deficits, thereby experiencing the impact of the global crisis on a greater scale.

Portugal, Ireland, Italy, Greece and Spain (so-called PIIGS countries) have been struggling with excessive macroeconomic imbalances, and as such they have been severely impacted by the crisis. Numerous problems that have been accumulated over the years and improper economic structure have been the biggest obstacle for a full recovery.

Figure 1 shows that those countries have recorded a high trade deficit for years before the economic crisis occurred. Greek current account deficit has surpassed 15 per-cent of GDP, Portuguese and Spanish deficit have surpassed 12 and 9 per-cent respectively and so on.

Ivica Brkljača

Even worse trends occurred in the new Member States of the EU. The South and East of Europe have therefore been the centre of the economic crisis, as well as the main reason why the financial crisis has lasted that long in the EU.

In figure 2 we can see current accounts of the newest EU Member States. Unlike trends in the core EU, all of the new Member States have been struggling with high current account deficits: from relatively high deficits (up to 5 percent) in Czechia and Slovenia, to enormous deficits in Bulgaria and Baltic states (above 20 percent).

In that sense, global economic crisis and the disruption of foreign capital flow resulted in greater negative effects on those economies. However, the way and pace of economic recovery had been put largely on the economic policies in each Member State. Croatia was a great example of how it was not supposed to answer the financial crisis due to a fact that country was in a continuous recession for six years, which is a rarity in the contemporary history of the global economy.

Ivica Brkljača

However, we should get back to the question about depth and intensity of the next recession, which will occur sooner or later. As seen in the attached graphs, the situation nowadays is notably different than it was in years before 2008: while PIIGS countries and the new EU Member States have had massive trade deficits ten years ago, today, most of them have a well-balanced or even a surplus on current account.

Macroeconomic imbalances, which most of the EU Member States have experienced ten years ago, have been recognized as the main risk of future economic crises. As a result of that, in 2011 the Macroeconomic Imbalance Procedure has been put in place, which is supposed to address the main risks. The main task of that corrective mechanism is to determine, prevent and remove potentially adverse macroeconomic imbalance that might harm regional or EU economic stability.

Due to a such a tool, 19 EU Member States have been recognized in the last 5 years as ones that have imbalances or excessive macroeconomic imbalances. Nowadays, only Italy, Greece and Cyprus are marked as countries with excessive macroeconomic imbalances.

In that sense, thesis that next recession that will be more devastating than the last Great recession, simply isn’t adequately backed up by firm evidence.

On the other hand, one has to acknowledge that monetary policy cannot be of bigger help this time, due to a fact that central banks are already holding interest rates next to a zero (i.e. already carrying out accommodative monetary policy). The risk of trade wars has to be mentioned as well. Implementing tariffs might trigger inflationary shocks, thereby motivating central banks to respond by raising interest rates to fulfil their main tasks of preventing high inflation, which then can slow down economic activity and even produce a recession, etc.

However, those could be interpreted as potential one-time shocks that will be addressed and somehow resolved sooner or later, but for the EU as a whole, it is important that today there aren’t excessive macroeconomic imbalances (like there used to be up to a few years ago) which would make a lot harder to start a new growth cycle. So, 'The great flood', which is announced by dire prophets, will not occur any time soon. How each country will manage to respond to the next 'normal recession' depends primarily on the quality of public policies of each Member State.