Eurozone Watch

3rd part of our series on the EU after the Irish No to the Lisbon Treaty  

The economic outlook for the euro area is deteriorating fast: This week has brought a number of new indicators pointing at a sharp slow-down ahead. Not only are signs mounting that the first countries on the fringe of the euro area such as Ireland and Spain may now be in recession, but there are now also some first indications that Germany, long seen as the most robust economy of the euro area at the moment, is also heading for a significant slowdown. Negotiations on an new protocol to complement the Lisbon Treaty or on a revised version of the Treaty will hence take place in a difficult economic setting. This could turn out to be particularly problematic for Ireland, which may face a second referendum on the Lisbon Treaty.

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2nd part of our series on the EU after the Irish No to the Lisbon Treaty  

The European Council on June 19/20, 2008 did not indicate a way out of the EU crisis which resurfaced with the Irish „No“ to the Lisbon Treaty on June 12, 2008. Nevertheless, one or two likely options are being sketched on the horizon.

Option one is to provide Ireland with a protocol to the Lisbon Treaty, which takes into account Ireland’s most important problems with the Treaty and possibly grants certain opt-outs of community policies. We discussed this scenario, which seems to have the largest support among EU member states at the moment here, explaining why the double-Nice-referendum of 2001/2002 cannot simply be repeated.

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1st part of our series on the EU after the Irish No to the Lisbon Treaty  

The European Council on June 19/20, 2008 did not indicate a way out of the EU crisis which resurfaced with the Irish „No“ to the Lisbon Treaty on June 12, 2008. But before and during the European summit, one “most likely” scenario emerged. The majority of member governments seemed to agree that the ratification process should be completed as far as possible – in order to get a clearer picture which governments or countries actually back or do not back the Treaty, and foremost, to put pressure on Ireland to negotiate some add-on to the Treaty and ratify it soon afterwards.

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Next Thursday, the ECB will most likely increase its interest rate by 25 basis points to 4.25 percent. Its president Jean-Claude Trichet has all but pre-announced this move and other members of the governing council have been busy underlining the message over the past weeks. This move could prove to be the most risky move ever done by the ECB - economically as politically.

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Everywhere across Europe, one can these days find conference discussing the achievements in 10 years of EMU. This week-end, I had the opportunity to go to Dublin to Euroframe's conference on that topic (see program here), presenting the latest findings of my joint research with Ulrich Fritsche and Ingrid Größl on divergences in EMU. As it turned out, Ireland has become one prime destination to visit the consequences of economic divergences in the euro-area.

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Two important political developments in the EMU surfaced on the ECB's tenth anniversary celebrations. Firstly, the EMU's fiscal policy coordination mechanisms are more in flux and under pressure than the EMU institutions would like to have the public believe since the reform of the Stability and Growth Pact. And secondly, the issue of lower than expected economic convergence within the Eurozone is receiving more and more attention: pro-longued business cyclces and cyclical divergence are now longer issues reserved for the macro-economic academic debate but are increasingly picked up by policy makers.

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Last Friday, Ulrich Fritsche and I presented the results from our analysis of unit labour costs in EMU compared to regional unit labour cost developments at a workshop in Cambridge (see paper here). When we remarked that Portugal had lost roughly 17 percent competitiveness between the start of EMU and 2006, more than has been ever observed in any German Land or US state within any 8-year-period, one discussant remarked that Portugal has actually improved competitiveness in 2007 and is set to do so again in 2008. So, is Portugal actually turning the corner after years in the doldrum?

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Today, GDP figures for Germany, France and the Euro-area as a whole were published. While the figures by itself might have been distorted by some one-off factors, the underlying divergence in the data is rather frightening. What has for quite a while been one of the top issues on Eurozone Watch is increasingly taken up by bank analysts: The growind divergence within EMU.

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Over the past week, the German economy has shown first real signs of an economic slow-down. Data from the labour market has been much less upbeat than before. Yesterday, also manufacturing orders took a hit, pointing to a further growth moderation starting in the second quarter of 2008. The strong euro and the investment backlash from the tax reform enacted on January 1 of this year are finally felt in the economy.

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Next Wednesday, May 7th, the European Commission will put forward a long-awaited report on the Eurozone. A few months ahead of the Euro's 10th anniversary, this report is unlikely to trigger a debate the EMU should go through, given recent developments, such as the increasingly observed cyclical divergence and prolonged business cycles that EMU is experiencing, and the economic tensions that are coming up e.g. for Spain. There is a (very) slight chance that the report is somewhat more ambitious regarding external issues, such as the international representation of the Euro, but it is again improbable that it will tackle the issue of what to do with the external value of the euro (i.e. how to manage relationships with the EMU’s major economic partners, the US, China, the UK, …). But let’s concentrate on the question what there is to expect for the internal aspects of EMU governance for the moment.

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