Download Europe`s economy

Global macro matters
Europe’s economy: A long haul
Whether this muted outlook is on or off the
mark depends on the answer to at least three
critical questions: Can fiscal policy become
more stimulative? When will bank lending grow?
and What more will the European Central Bank
(ECB) do?
Debt not especially high for aggregate euro
area; but no appetite for more fiscal stimulus
Neither private- nor public-sector borrowing
levels are particularly high in the aggregate euro
area, compared with those of the United States
or the United Kingdom. The bigger issue is the
regional composition of debt.
In parts of periphery Europe, debt has risen
sharply as bank losses, fed by impaired private
debt, have prompted the need for publicly
funded recapitalization. These public borrowing
needs have been heightened by depressed
economic activity. Partial debt default has
ensued (in Greece), along with the need of
some countries (Greece, Ireland, and Portugal)
for external financing assistance. But calls for
wider debt forgiveness or looser fiscal policy
to provide stimulus to the region have been
resisted in the creditor countries,
especially Germany.
6%
€500
4
400
2
300
0
200
Deflationary
force?
–2
–4
–6
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
100
0
–100
2014
Year-over-year absolute change
(€ billions)
Recent economic reports reinforce an outlook
of meager growth into 2015, with real GDP
expanding at best by about 0.5%–1%.
Year-over-year percentage change
Since the onset of the sovereign debt crisis in
2009, we have maintained that the euro area
would remain intact, but that the European
economy would struggle to grow meaningfully,
given banks’ deleveraging and high debt levels
in Europe’s periphery countries.
Real GDP growth is failing to recover, given contracting bank
credit and rising risk of broader price deflation across Europe
Real GDP (at left)
Bank lending to households (at right)
Note: Household loans include loans to households and nonprofit organizations.
Sources: Vanguard and Eurostat calculations, based on ECB data.
Evolution of private- and public-debt ratios (2003–2013): Selected
periphery countries, France, Germany, euro area, United States,
and United Kingdom
Outstanding debt (% GDP)
Europe’s economy is risking a Japanese-style
decade of near-zero growth and deflation
Vanguard research | Joseph Davis, Ph.D. | November 2014
500%
400
300
200
100
0
Ireland Portugal
Public 2003
Private 2003
Spain
2008
2008
Greece
Italy
France Germany Eurozone
U.S.
2013
2013
Note: Private debt comprises sum of borrowing by households and nonfinancial corporations.
Sources: Vanguard, based on data from Thomson Reuters Datastream, Moody’s Analytics Data Buffet, ECB,
Banque de France, Eurostat, Federal Reserve, and U.S. Bureau of Economic Analysis.
U.K.
Banks retrench, but are now better capitalized
An important consequence of the financial crisis
is that it exposed the weakness of European
banks’ balance sheets. This weakness occurred
both because of banks’ earlier overexpansion
and, more recently, because of lackluster
economic activity, which has forced banks’
losses to be written off. Tighter regulatory
requirements aimed at preventing repetitive
problems have required ongoing retrenchment
by the banks. Injections of public and private
capital have been needed as well as a radical
scaling back of balance-sheet size (assets fell
–12%, by €3.4 trillion, for the years 2011–13).
And, significantly, new regulations have also
involved aggressive deleveraging, with much
tighter lending conditions.
As a result, we predict that bank lending in Europe
will not begin to grow again until next year.
Europe needs bank lending to grow,
a challenging task for the ECB
Improving capital ratios are partly achieved by shrinkage
of European banks’ balance sheets
€30
13.5%
13.0
29
12.5
28
12.0
27
11.5
26
11.0
25
10.5
24
23
10.0
Dec. 2011
June 2012
Dec. 2012
June 2013
Dec. 2013
Tier-1 capital ratio (weighted average, at left)
Total assets (€ trillions, at right)
Note: Capital ratios and balance-sheet size refer to aggregate of euro-area banks overseen by European Banking
Authority (EBA).
Sources: Vanguard calculations, based on EBA Key Risk Indicator Database.
The necessity for bank deleveraging presents
a paradox for European policymakers—about
80% of corporate funding in the euro area is
intermediated through banks, compared
with about 20% in the United States.
The ECB has recently announced stimulus
plans, providing targeted liquidity to banks
and buying securitized bundles of bank assets.
The plans are designed primarily to encourage
prudent bank lending, especially to smaller
companies.
Although we believe these efforts will have
a positive effect, experience in the United
States and the United Kingdom suggests
that if deflation is to be avoided, the ECB’s
balance sheet may need to expand even
further, including outright quantitative easing
via purchases of sovereign bonds. For now,
political opposition, mainly from Germany, is
preventing such decisive action. We believe
chances are roughly even that this policy will
be adopted, probably in early 2015.
Total assets as percentage
of 2008 money GDP
(Jan. 2008 = 100)
Global central bank assets as percentage of a region’s 2008 money GDP
500%
Lehman Brothers collapse
400
300
200
100
0
2007
2008
2009
2010
2011
2012
2013
2014
Federal Reserve
European Central Bank
Bank of England
Notes: Total assets for each central bank are shown as a percentage of that country’s/region’s 2008 GDP.
Data as of September 7, 2014.
Sources: Vanguard calculations, based on data from Federal Reserve, Bank of England, ECB, Bank of Japan,
and International Monetary Fund.
Connect with Vanguard® > vanguard.com
Vanguard global economics team
Joseph Davis, Ph.D., Global Chief Economist
Europe
Peter Westaway, Ph.D., Chief Economist
Biola Babawale
Georgina Yarwood
Asia-Pacific
Alexis Gray
CFA® is a registered trademark owned by CFA Institute.
Americas
Roger A. Aliaga-Díaz, Ph.D., Principal and Senior Economist
Andrew Patterson, CFA
Vytautas Maciulis, CFA
Ravi Tolani
Zoe B. Odenwalder
Vanguard Research
P.O. Box 2600
Valley Forge, PA 19482-2600
© 2014 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing Corporation, Distributor.
ISGGMMEU_ 112014