Eurozone: The fiscal consolidation conundrum for governments

Widespread fiscal consolidation will constrain near-term eurozone growth. But with growth becoming more reliant on private demand, the uncertainty about the magnitude and duration of the cyclical rebound means risks to growth are tilted to the downside.

What you will learn:

• Fiscal consolidation by eurozone countries will be more gradual and around half as strong as that of the crises of the early 2010s. It will also be more targeted at reducing extraordinary support measures from the various crises of recent years, lowering the risk of damaging long-term growth which could undermine fiscal consolidation.
• There are downside risks if the withdrawal of support measures hurts the consumption recovery. But we think households are well positioned to absorb reduced government support. Strong wage growth and elevated savings rates – bolstered by higher deposit rates – should provide a buffer to support the consumption recovery.
• Robust global demand, a competitive currency, and expected significant monetary easing will support private demand. The risk of private sector deleveraging is low as balance sheets are free of the significant external imbalances of the late 2000s. But many eurozone countries will tighten spending at a time when demand is weak, which may undermine efforts to rein in budget deficits.
• Successful fiscal consolidation will contribute to limiting debt issuance and rollover risks at a time when the European Central Bank withdraws from the sovereign bond market. But improvements may be uneven if consolidation plans in high-deficit economies run into political pressure. Fiscal consolidation also presents a downside risk if the reintroduction of EU fiscal rules staves off longer-term government investment that undermines potential growth.