European economics continues to be in the news and remind the global markets of the weakness on the continent. European government bond yields continued to fall to historic levels as data from the area continues to weaken. The next few meetings of the European Central Bank (ECB) will be critical in turning the tide as markets are expecting the ECB will engage in quantitative easing (QE).
But even as markets expect QE, there are the inevitable arguments as to how Europe got back into a mess, even as we entered this year with high hopes that Europe’s economy had put the worst behind it. But the more important argument is over what are the right policies to get it back on track? A big part of this argument is whether or not Europe should continue to focus on fiscal austerity, particularly big cuts in government spending.
This argument came to a head in dramatic fashion this week when French President Francois Hollande fired his Economy Minister Arnaud Montebourg. Mr. Montebourg is known as a firebrand defender on the leftwing of Hollande’s party and for calling for more stimulus as the priority rather than fiscal austerity. His swift removal by a president with only a 17% approval rating from the French electorate certainly qualifies as a rather bold political gamble.
The political firestorm laid bare the stark differences in policy that simmer just beneath the surface. The core and northern European countries want the rest of the eurozone to exhibit the kind of fiscal discipline that all agreed to when joining the eurozone. The southern countries see austerity as preventing the kind of growth that the European economy needs. This leads us to repeat the central problem with the eurozone — you can’t have a true economic union without ironing out a lot of core issues like government spending, labor markets, and taxation, etc.
Our View: The ECB will embark on QE, which will no doubt help the European economy in the short-term. However this takes off the pressure to engage in meaningful reform and policy alignment on issues outside of the ECB. Unfortunately we do not see where leadership will come from that will break through the resulting complacency and tackle the hard choices Europe needs to make.
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