The slowing euro zone economy needs pre-emptive fiscal stimulus from cash-rich countries like Germany and the Netherlands or it will face a long period of low growth, the European Commission will tell euro zone ministers next week.
In a discussion paper prepared for the next meeting of finance ministers from the 19 countries sharing the euro in Luxembourg on Wednesday, the European Union executive arm says euro zone economic activity will not rebound this year.
The paper, seen by Reuters, echoes the words in September of outgoing European Central Bank President Mario Draghi, who urged governments to help monetary policy efforts by stimulating growth with fiscal policy as well.
“The slowing growth and the downside risks inherent to the current situation may call for a pre-emptive, rather than reactive, approach to fiscal policy,” the Commission said in the document.
It said governments should move now because it takes time for fiscal policy changes to have an impact on the economy.
The Commission addressed its call mainly to Germany and the Netherlands, usually referred to as “countries with fiscal space,” because they have had budget surpluses for years.
The two should invest more to stimulate growth as well as to prevent the deterioration of public infrastructure, like German motorways or bridges, because that in turn would hit their longer term growth.
Yet German Chancellor Angela Merkel, while acknowledging last month that governments should act not to overburden the ECB, has also resisted calls to draft a fiscal stimulus package for her country even though Europe’s biggest economy is teetering on the brink of a recession.
The Commission paper said, however, that Italy or Greece, referred to as “high-debt member states” because they have the highest public debt levels in Europe, should pursue policies to make sure markets believe that their debt will fall.
The document said that to spur growth, further ECB monetary policy easing would be less effective and have larger unwanted side effects than fiscal stimulus by governments, which now would be more effective than in normal economic times.
“Uncertainty related to trade policies, geopolitical tensions and the future relations between the EU and the U.K. are likely to remain over the coming years,” the paper said, referring to a U.S.-China trade war and tensions with Russia and in the Middle East as well as Brexit negotiations.
“Moreover, negative structural factors (e.g. demand shifting away from diesel engines, structural transition in China) are likely to continue weighing down on growth. This raises the possibility of Europe remaining longer on a lower medium-term trajectory of output than earlier expected,” it said.
The Commission said its base scenario of slower economic growth did not include an escalation of tensions in the world or a full-blown trade conflict between the United States and Europe that would include tariffs on EU cars, or Britain exiting the EU without a divorce agreement.
“The probability of such events materializing in the near-term is elevated and their impact on the European economy might be substantial,” the Commission said.
The ministers’ talks on Wednesday will be followed by discussions on how to fund a euro zone budget for investment of some 17.5-billion over seven years. France wanted this budget to be more than 10 times bigger, but the Netherlands fiercely opposed that.