The Eurozone: An Example of Failed Keynesianism

The Eurozone: An Example of Failed Keynesianism
The colors of the European Union illuminate the south facade of the European Central Bank headquarters in Frankfurt, Germany, on Dec. 30, 2021. (Reuters/Wolfgang Rattay
Daniel Lacalle

The eurozone economic figures show the risk of stagflation, and the short-term impact is clear in Germany and France, but it also extends to the rest of the countries.

Why has the eurozone lagged behind the United States and other developed economies in recent years? The enormous stimulus packages, including the 2009 Growth and Jobs Plan, the Juncker Plan, the Green New Deal, and the Next Generation EU, are proving that central planning only delivers poor growth, elevated debt, and now high inflation.

The European Central Bank’s (ECB) latest figures show that monetary aggregates are starting to moderate, but inflation remains high and, in the latest print, is rising.

Consensus estimates of gross domestic product (GDP) growth in 2023 stand at 0.6 percent, with inflation above 5 percent, according to Bloomberg, and it's important to remember that core inflation continues to be three times higher than the target of price stability.

ECB President Christine Lagarde’s inflation messages seem clear, but the ECB’s target must be met, and interest-rate increases are here to stay, although the market estimates that the ECB will start lowering interest rates by 2024. The problem is that the eurozone is only betting on rate hikes to moderate inflation, while governments continue to spend billions of euros on so-called Next Generation funds and deficits that mean more inflation or taxes in the future.

We shouldn't be surprised that credit in the eurozone is falling along with monetary aggregates. The entire burden of monetary normalization is falling on the productive sector, families, and businesses, while many governments continue to increase deficit spending.

The figures for growth in the eurozone are very poor, but they're even worse when we take into account that Ireland's progress, as shown by Eurostat, almost entirely explains the most recent upward revision. What does the eurozone do? Instead of incentivizing the economic freedom model, it subsidizes the intervened ones.

The economy is expected to grow slightly in 2023, plagued by high inflation, rising interest rates, and lower exports. The Next Generation funds have no discernible marginal or multiplier effect.

The weak state of manufacturing and service indexes confirms this fear. Purchasing managers' indexes show a widespread negative trend in new orders and investments.

Rate hikes aren't enough when the ECB's balance sheet is 52 percent of GDP. Harmonized inflation fell to 5.3 percent in July from 5.5 percent in June because of the base effect and the decline in commodities. However, commodities have been bouncing since May, when the market started discounting the end of rate hikes.

We can't ignore the fact that the data on eurozone inflation expectations are rising and that inflation was at its peak in 2018.

The ECB raised its benchmark interest rate to 4.25 percent from 4 percent, a cumulative increase since July 2022 of 425 basis points. I believe that it'll end in 2023 at 4.43 percent and in 2024 at 3.68 percent, but without finishing the inflation battle.

Despite trillions in deficit and growth central plans, the eurozone faces an environment of poor growth and high inflation with strong headwinds, led by an increase in energy costs and the lagging effect that rising rates can generate, as interest-rate increases don't show their full effect on the economy until 12 to 18 months after they're completed, according to the ECB’s estimates.

We would also take into account the European Union's technological problems. While the United States and China are leading global technological advances, it seems that the EU has lagged in growth and investment but above all in patents and technology companies. The EU doesn't have technology giants that can challenge global leaders, and one of the factors that worries us most is the very high level of taxation. It works against the opportunities for creating world-class tech giants.

According to the European Commission itself, taxation in Europe remains at a very high level for capital (27.8 percent) and labor (21 percent)—two key factors for the development of technology companies. Such high taxation jeopardizes innovation, the attraction of investment, and the improvement of human capital.

If there's a lesson for the United States and the rest of the world, it's that massive central planning doesn't deliver growth and that governments don't lead economic development and innovation. The eurozone would benefit from a supply-side, bottom-up approach to the economy. Unfortunately, it's doubling down on central planning.

Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.
Daniel Lacalle, PhD, is chief economist at hedge fund Tressis and author of “Freedom or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.”
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