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euro zone fiscal and monetary stimulus

November 2019

The euro zone: a blueprint for a brighter future

The euro zone's new stimulus package could deliver the biggest monetary and fiscal boost since 2008. And it's also a sign that the region is putting firmer foundations in place.

The contours of a new plan to jump-start euro zone growth are emerging, just days after the region installed Ursula von der Leyen and Christine Lagarde as its new policy chiefs. 

And it’s a plan that promises the biggest coordinated stimulus since the 2008 financial crisis.

Based on the 2020 draft budget submitted to the European Commission, we expect the euro zone to deliver the most generous tax cuts since 2010, a fiscal boost that’s equivalent to 0.3 per cent of GDP.

The bulk of the stimulus will come from Germany, whose manufacturing-heavy economy is flirting with recession. Germany’s fiscal stance, adjusted for the economic cycle and certain one-off effects, will swing to an expansionary 0.8 per cent of GDP next year from -0.7 per cent in 2018.

However, even this is unlikely to be enough. Germany accounts for nearly a third of euro zone GDP, and our analysis shows that its 2020 spending plan will add no more than 0.4 percentage points to the country’s growth for the same year (see chart).

germany's fiscal boost
German fiscal impact on growth

Source: Pictet Asset Management, CEIC, Refinitiv and Bloomberg, data as of 08.11.2019

It is no surprise, then, that German lawmakers are seeking to relax their long-cherished commitment to maintaining a balanced budget.

Chancellor Angela Merkel said in October that Germans shouldn’t become obsessed with its schwarze Null policy and that investing in the future is also a priority. Finance Minister Olaf Scholz has also suggested the government could spend an extra EUR50 billion.

Public investment is something which the IMF has urged Germany to do. It is also what the European Commission President-elect has pledged for the wider bloc in her manifesto, calling on the EUR 1 trillion spending on sustainable projects over the next decade.1

Berlin can also cut social security contributions or introduce incentives to buy durable goods, giving an immediate boost to household income that could underpin consumer spending.

For any fiscal stimulus to be effective, however, it is crucial that the central bank plays its part too. This is because higher government spending can, counter-productively, lead to higher borrowing costs.

The ECB is already increasing the stock of money in the financial system to keep interest rates low.

Under the new package unveiled in September, it provides EUR20 billion of fresh stimulus a month. Assuming that the ECB will run the programme at the same pace until it reaches the self-imposed limit, we expect the bank to inject close to half a trillion euros over the next two years.2  This would increase the region’s liquidity supply to its highest level since 2014 and above the 12-year average.3

The ECB could also revamp its existing credit programme, known as Targeted Longer Term Refinancing Operations (TLTROs). At the most extreme, it could dramatically ease the terms of this programme by offering, for example, a perpetual credit line to struggling banks. Or it could resort to a Japan-style yield curve control policy. 

The new ECB chief Lagarde may not need to go that far after all. But should global economic conditions worsen, the ECB, as well as the region’s governments, have plenty of options left in their crisis toolkit to support growth.

And it is for these reasons that, as we argue in our Secular Outlook, the single currency bloc will spend the next few years laying the foundations for a brighter future.