Economic Survey 4-2011

The European crisis became more serious this autumn, largely because the politicians failed to reach agreement on measures to convince the market that their government debt was manageable. Yields on government bonds in many countries rose substantially right until the end of November. In early December, however, yields fell in the wake of interventions by a number of central banks, proposed budget cuts in Italy and expectations of further action by the European Central Bank (ECB) and the EU in the near future. However, financial markets remain volatile, and if expectations are not met, yields may rise again. A solution to the crisis now will probably entail both the ECB changing its focus from the role of defender of low inflation to printing money in order to purchase government debt, and the introduction of more stringent requirements regarding budgetary discipline for countries that are to receive emergency aid to finance their debt. In the longer term, closer cooperation on fiscal policy appears inevitable if the euro is to survive. How this will take place is currently being discussed by the political leaders in the euro area. We assume that the ECB and the euro area will regain market confidence by introducing adequate saving measures and structural changes without completely stifling growth. Even if they succeed, we envisage several years of weak economic growth and brief periods of minor falls in GDP in the euro area. Should the euro collaboration collapse, we will be in unknown terrain, making it virtually impossible to predict developments, but it will probably take the entire OECD area into a pronounced recession. Although developments in early December have made this somewhat less probable, the risk is still there.