Europe’s Lost-and-Found Decade

It is unlikely that Europe’s economy will follow the pattern of emerging-market crises and rise, phoenix-like, from the ashes. But, for better or worse, the fact that the most severe political and social turbulence is yet to come at least means that Europe will be unable to afford the dithering that produced Japan’s lost decade.

BRUSSELS – Sentiment in European financial markets has turned. For the moment, the possibility of a Greek exit from the eurozone is off the table. If interest-rate spreads on Spanish and Italian government bonds are any guide, bondholders are no longer betting on a eurozone breakup. European stocks even rose in the week following last month’s inconclusive Italian elections.

Investors evidently believe that Europe’s leaders will do just enough to hold their monetary union together. But, at the same time, it is unlikely that Europe’s economy will follow the pattern of emerging-market crises and rise, phoenix-like, from the ashes. Rather, the most likely scenario appears to be a Japanese-style lost decade of slow or no growth.

The first obstacle to a “phoenix miracle” is that governments remain in austerity mode. Yes, there are whispers that the pace of fiscal consolidation could be slowed; indeed, France has already been given more time to hit its deficit target. But this looks a lot like Japan, where the fiscal tap was tentatively opened and closed. Japanese consumers knew that increases in public spending were temporary, so they did not change their spending habits, rendering the policy ineffectual.

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