Earlier in 2021 most economists, including those within international organisations, predicted that recovery from the outbreak of the Covid-19 pandemic would be much faster in the US than in Europe. A faster vaccine rollout and the huge fiscal stimulus announced by the new Biden administration, in contrast with the EU’s inherent institutional problems and its initial problems with vaccine production, all seemed to point in this direction. However, within a few months the situation has changed completely. Improvements in the health situation and the relaxation of the pandemic containment measures allowed for the reopening of most sectors, including business services and tourism. Combined with strong consumption, recovery in Europe exceeded expectations, whereas the third wave and resistance to vaccination in large pockets of the US slowed down the economy.
The result is that the euro area has now caught up. In real terms, the euro area’s GDP is above the level of Q12020 (see Figure 1) and, in the last two quarters, recovery appears faster than in the US. Compared to the Global Financial Crisis (GFC), the pattern is very different with a clear V shape recovery
The figure also illustrates that the US did much better that the euro area during the GFC, with a somewhat lower fall in activity and a stronger recovery. Thus, this time round seems different on two accounts: the recovery has been V-shaped (or close to V-shaped) on both sides of the Atlantic and this time the euro area has recovered as quickly as the US.
This quick recovery of the euro area economy has potential important implications for the role of fiscal policy. In the US the fiscal support has been extraordinary with the deficit reaching close to 16 % of GDP whereas in the euro area the average fiscal deficit is now (according to the Commission’s autumn forecast) estimated to be only slightly over 6 % of GDP. Although the deficit was higher in the US by more than 9 percentage points of GDP, a huge difference in support to demand, the US economy does not seem to have recovered more quickly. This inefficient fiscal policy for supporting consumer demand in a recession (as people withhold from spending because they become afraid for their financial future), was foreseeable, and indeed foreseen in an earlier CEPS publication. The transatlantic comparison provides an impressive confirmation of this hypothesis.
Future forecasts: Looking good… for now
The newly published autumn forecasts from the European Commission, entitled ‘From recovery to expansion, amid headwinds’, confirm a positive outlook for the EU with potential headwinds of a short-term nature (such as the beginning of a so-called ‘fourth wave’ over the autumn of 2021). However, as the virus becomes endemic, the way governments will deal with it, i.e. whether some containment measures will be reinstated, will impact growth, especially through the service sector.
Another challenge is that, this year, the EU economy is still receiving support from expansionary fiscal and monetary policies. At the national level deficits will soon start to be reduced, however consolidation in national expenditure will be offset by funds from the Next Generation EU programme. These funds have already started flowing to Member States, but will become more substantial next year. Moreover, as shown above, fiscal support has not been the only factor driving the quickest recovery the European economy has ever recorded.
Taking a more medium-term perspective, the pandemic has accelerated automation and altered consumption patterns, presenting the challenge of deeper structural change. This is the key challenge going forward for the EU.
Meanwhile, the US will be faced with greater fiscal consolidation needs than Europe but it might have an advantage in adapting faster to a highly digitalised ‘endemic Covid’ economy. The European economy has had an impressive bounce back (admittedly to the surprise of many) – now it really needs to show that it can grow, prosper and succeed as we move into the new post-pandemic green and digital world.