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Revamping Europe’s Tattered Social Contract

WASHINGTON, DC – For most of the beginning of 2014, the eurozone seemed to be in a state of recovery – weak and unsteady, but nonetheless real. In April, the International Monetary Fund estimated that overall GDP growth would reach 1.2% this year, with slowly declining unemployment, up from its previous forecast of 1% growth. With the threat of unsustainably high interest rates in the countries of the eurozone periphery having disappeared, the path to moderate recovery was supposedly open, to be followed by some acceleration in growth in 2015.

While it is important not to overreact to quarterly figures, recent data, as well as some of the revised data for the first quarter, are deeply disappointing. The pessimism of two years ago has returned – with good reason.

Italy is in an outright recession, and, far from showing hoped-for signs of vitality. French growth is close to zero. Even Germany’s GDP declined in quarterly terms in the first half of the year. Finland, a staunch supporter of firm austerity policies, is in negative territory for the first half of the year.

Nominal interest rates for periphery countries’ sovereign debt have remained extremely low, and, even when taking into account expectations of very low inflation (or even deflation), real interest rates are low. The eurozone now is facing not only a financial crisis, but a stagnation crisis. Tensions with Russia may make recovery even more difficult, and it is unlikely that the eurozone can attain 1% growth in 2014 without major policy changes.