Beneath the headline-grabbing numbers showing on Thursday that the euro zone has fallen into recession, there lies a more positive and probably more important story: the growth trajectories of the currency bloc’s four largest economies have moved considerably closer together.
The convergence of Italy and Spain, the two economic weaklings of the quartet, with the strongman Germany, and France, which had recently been caught somewhere in the middle, eases the risks posed by the biggest design flaw of the euro zone. This is the fact that, because of the absence of a true fiscal union, it is only as strong as the weakest of its most powerful constituent parts.
The bad news of the day was that the euro zone has entered its second recession since 2009, after gross domestic product (GDP) declined by 0.1 percent from July to September, on a quarter-over-quarter basis. This marked the second straight quarter of falling output — the most common definition of a recession. As a result, the euro zone economy is now 0.6 percent smaller than it was a year ago.
However, this mild third-quarter decline was both less steep than forecast and even less pronounced than in the second quarter, when GDP fell by a fairly gentle 0.2 percent. There was, moreover, a rather benign devil in the details. Output in Italy, until Thursday the weakest economy among the euro zone’s four leading nations, shrank by only 0.2 percent in the third quarter — a considerable easing from 0.7 percent for April to June, and a nadir of 0.8 percent in the first quarter. Spain’s decline in output also eased slightly, to 0.3 percent. In both countries the speed of the fall has slowed to its gentlest pace in a year. France confounded skeptics who cavil at its inclusion in the “core” of inherently healthy euro zone economies, by growing for the first time since the fall of 2011. Its better-than-expected performance was thanks partly to strong exports.
By contrast, some other economies which are more consistently placed by analysts in the core performed worse than before. Growth in Germany eased by 0.1 percentage points to 0.2 percent, with Austria and the Netherlands tipping from growth into decline.
The euro zone sovereign debt crisis, which has continually dominated international financial markets for more than a year, would, naturally, be much nearer its end if the euro zone was experiencing overall output growth rather than decline. However, Thursday’s figures suggest that the nature of the decline is far less poisonous than in the second quarter, when both Italy and Spain were shrinking faster than now.
Since the euro zone crisis began, the currency union as a whole has managed to find the resources to bail out the bond markets of economic minnows — such as Greece — which account for only a small fraction of the bloc’s overall output. However, institutional investors’ greatest fear has been that a national bond market not big enough to swallow, such as Italy’s or Spain’s, would sink into potentially terminal decline because of a spiraling economy. Thursday’s numbers indicate that this is less likely.
A detailed breakdown of the Italian figures is not due until December. However, Axel Lang, European economist at Credit Suisse in London, credited their sharp improvement to “stabilization in financial market conditions” following action by the European Central Bank (ECB) to support troubled euro zone peripheral states, and to a “marginal easing in fiscal tightening” by the Italian government. He predicted that the Italian economy would stop contracting altogether in 2013.
A flurry of measures taken this year by ECB president Mario Draghi to ease the euro zone debt crisis, including attempts to strengthen the euro zone framework for collective aid, have pushed the yields on Italian 10-year bonds down from above 7 to under 5 percent — puncturing a sense of panic among Italians about their country’s future, which had stifled investment by businesses and spending by households. Responding to Thursday’s figures, the yield on Italian 10-years fell by another 5 basis points to 4.91 percent,
Many analysts think the distribution of output within the euro zone matters as much as overall total output, given the unbalanced nature of the euro zone’s economic union. Institutional investors in German, French or Finnish bonds, to take three euro zone examples, would be relaxed about abysmally low Italian output if these markets were not incorporated within the currency union, since a slump-induced default by Italy would in such a case have no effect on the currency in which German, French or Finnish bonds were priced. On the other hand, the same investors would also be relatively calm about poor Italian output if there were a full fiscal union with smoothly oiled working parts, which transferred revenue from each country according to its ability to each country according to its need. This because in such a system, each country’s output — the origin of its tax revenue — would be less relevant to its fiscal position than overall output in the euro zone as a whole.
The euro zone is, however, stuck with a currency union and without a fiscal union. This leaves it exposed to economic catastrophe in a single member state, but with only limited ability to solve it. Draghi has made valiant efforts to compensate for the absence of fiscal union by creating a more effective financial fire department for member states, but institutional investors have no real idea about several of the nascent system’s characteristics. These include how long it would take before a fire truck was dispatched to put out the conflagration in a member state, whether the truck would be sent back to its station because a member state failed to make enough effort on its own to extinguish the fire, or how much water would be in the hose.
In the absence of these guarantees, Thursday’s figures provide a reassuring sense that some of the heat has been taken out of the Italian and Spanish recessions.
