Is economic recovery around the corner, as promised by the leaders of the G8, the group of the world's richest countries that held their annual meeting in Evian, France last week? Many economic stars are indeed aligned for recovery, both in the US and in Europe.

Oil prices are coming down from their highs during the Iraq war and, under plausible scenarios, may be heading for a greater fall. Investors all over the world are emerging from their Brazil-Enron-Iraq jitters. The risk premium is falling, pushing stock prices higher and lowering yields on long-term bonds.

Moreover, the overhang of excess capital that accumulated during the crazy high-tech boom of the 1990's has now been mostly worked out. Investment rates have been low for three years in a row. Now only a few sectors suffer from excess capital accumulation. Firms are ready to invest again.

All good news. But there, alas, the similarities between Europe and America end. Monetary and fiscal policy are working at full throttle in the US, but are muzzled in Europe.

In the US, Federal Reserve Chairman Alan Greenspan did his job in 2001 and 2002, aggressively cutting interest rates. When monetary policy could not do much more, the Bush administration took up the charge--and with relish.

The US budget has gone from a surplus of 1.4% of GDP in 2000 to a forecast deficit of 4.6% in 2003, a 6% swing--of which about 5% is due to changes in policy rather than the weak economy. This may be fiscally irresponsible (together with the tax cuts put in place for the future, it surely is irresponsible), but in the short run, it provides an enormous boost to demand.

In Europe, however, the European Central Bank (ECB) has been far more careful. True, as a new institution it has had to establish its credibility, but the result is a smaller, slower decrease in interest rates.

Fiscal policy in Europe is constrained by the Stability and Growth Pact. The budget for the Euro area has gone from a surplus of 0.1% in 2000 to a forecast deficit of 2.4% for 2003, nearly all of it due to the weak economy, not to changes in fiscal policy. Governments tinker at the margin, cheating a bit, and get reprimanded by the European Commission in Brussels.

In the best of scenarios, what will happen is likely to fall short of the major short-run fiscal expansion Europe needs. This would require Europe's governments to increase their deficits in the short run, while improving the long run outlook through serious pension reform. Some governments--most notably France and Germany--are trying to do the second. They should feel freer to do the first.

America and Europe are not only following divergent economic policies, but their currencies are also diverging because the world is going through a major exchange-rate realignment. The dollar is depreciating, while the Euro is appreciating mightily.

There is a deep and sad irony to the current depreciation of the dollar. The depreciation is the price America must pay for past sins--i.e., a huge current account deficit that foreign investors are no longer willing to finance, at least not at the size of 4% or more of US GDP. The irony is that this dollar adjustment is unambiguously good news for America, and unambiguously bad news for Europe:

For the US, the dollar's fall means a boost to exports, and a further increase in demand, a further push for recovery. It also means a bit more inflation, but in today's world, a bit more inflation is good, not bad.

For Europe, the rising Euro means lower competitiveness and further economic contraction. The effects are far from negligible: The best estimates are that a 10% appreciation of the Euro will bring a decrease in demand and output of 0.6% of GDP in the Euro area.

So far, the Euro's appreciation is close to 30% from the lows of two years ago, and there is every reason to believe that even more strengthening is to come. The Euro is the only currency against which the dollar can depreciate. (The last thing Japan needs is an appreciation of the yen.) It will take more than what we have seen so far to return the US current account deficit to reasonable proportions.

With contraction and Euro appreciation comes the specter of falling prices, with which Europe is already flirting. The Euro's appreciation may well be the tipping factor that triggers deflation. As the now ten-year-old Japanese slump tells us, once deflation and contraction have established themselves, standard policies stop working. Europe does not want to find itself in this position.

So, the G8 leaders are half right. Between falling oil prices, aggressive fiscal and monetary policies, and the dollar's depreciation, it is hard to see what stands in the way of a strong recovery in the US. But this does not translate into recovery in Europe.

In Europe, monetary caution, self-imposed fiscal constraints, and the Euro's appreciation all lead to clear dangers: deflation and a prolonged slump. This is not preordained; many fundamentals in Europe are right, and a simple change in mood may spur recovery. But this is the time for strong contingency plans. Sadly, I do not see them being prepared.