Europe: Policy options in 2017 - Rabobank

According to the research team at Rabobank, one important area of uncertainty concerns what policy Europe will adopt in 2017.

Key Quotes

“In a positive outcome, we could see a grand bargain, in which the financially stronger countries such as the Netherlands and Germany ease budgetary policy while the weaker Member States that are still lagging with regard to financial reforms can catch up and introduce economic reforms whereby their economies can function more efficiently. While such reforms will increase the growth potential of the countries concerned over time, their effect on the economy in the short term will be negative. This is why budgetary policy needs to be eased in the coming years, as this will give the weaker Member States more time to get their finances in order.”

“The surplus countries, which in this context concern the countries with a current account surplus in the balance of payments, would have to implement a powerful expansion of their budgetary policies. This would not necessarily mean that the criteria of the Stability and Growth Pact ﴾SGP﴿ would have to be stretched without limit. It would however be a good thing if the SGP could offer more flexibility for investment in infrastructure that increases productivity. This budgetary easing would not only focus on boosting economic activity and creating jobs, but also on strengthening the growth potential of the European economy. This means investment in infrastructure, sustainable energy, education and research.”

“The result could be that Europe‐wide economic growth would pick up substantially, leading to a clear reduction in unemployment across the board. The quality of growth would also improve, since business investment in new equipment leads to an acceleration of the rate of growth in labour productivity.”

“This positive policy would also be a way of normalising monetary policy over time. The policy of quantitative easing could be dismantled. Policy interest rates would remain low for a while, leading to a return to a positive yield curve. The policy initiative described here would require much courage, determination and a European consensus. There is a good chance that it will not succeed.”

“In this case, the EU will continue to struggle. The upcoming elections in many EU countries may well be a turning point in this respect. Anti‐European electoral success could lead to a loss of confidence in the existing policy consensus. This would make it highly likely that an increasing number of countries will ignore the budgetary agreements, leading to a significant deterioration in government finances, especially in southern Europe and France ﴾the ‘periphery’﴿. If market conditions so dictate, the peripheral countries could decide to immediately place new government debt with their central banks, whereby they would completely ignore the explicit prohibition of monetary financing as included in the European treaties. It could even be the case that Germany, which strongly believes in the prohibition of monetary financing, would decide to leave the euro. In the worst scenario, this could lead to the dissolution of the eurozone or perhaps even the EU.”