Should the Eurozone rely on the US?

by Christophe Blot, Caroline Bozou and Jérôme
Creel

The Covid-19 pandemic has led governments and
central banks around the world to implement expansionary fiscal and monetary
policies. The United States stands out for its substantial fiscal support,
which is much greater than that in the euro area. In a recent paper prepared
for the Monetary Dialogue between the European Parliament
and the European Central Bank,
we review these measures and discuss their international implications. Given
the size of the US stimulus packages and the weight of its economy, we can
indeed expect significant spillover effects on the euro area. However, the
impact will depend not only on the orientation of economic policy but also on
the precise nature of the measures adopted (transfers, spending and the
articulation between monetary and fiscal policy).

Expansionary monetary policy is generally perceived
as a policy based on self-interest, since a fall in the US interest rate should
lead to a depreciation of the US dollar that is unfavourable to America’s trading
partners. However, the literature shows that the exchange rate channel can be
dominated by a financial channel and by increased demand from the US economy,
both of which generate positive spillovers (see Degasperi, Hong and Ricco, 2021).

The international spillover from US fiscal policy
should also be positive, once again via demand effects, and
also due to an expected appreciation of the dollar (see Ferrara, Metelli, Natoli and Siena, 2020) as well as from expectations of a return to
balanced public finances à la Corsetti,
Meier and Müller (2010).
The favourable impact on the rest of the world might also be attenuated if the
US fiscal expansion were to lead to a rise in the global interest rate. Ultimately, the magnitude of the international
spillover effects of US fiscal policy will depend on the response of the
exchange rate and the interest rate. Faccini, Mumtaz and Surico (2016) confirm the importance of financial effects but nevertheless
show that the real interest rate could fall after a US expansionary shock.

In this paper, simulations conducted using a macroeconomic
model and empirical analysis confirm the positive effects of US expansionary
monetary policy on euro area GDP. There is, however, uncertainty about the
timing and duration of these positive effects.

As regards fiscal policy, empirical analysis
suggests that the spillover from the US measures implemented since the outbreak
of the Covid-19 crisis will be positive, at least in the short term (in the
first two years). Given the size of the fiscal impulse, the impact would not be
negligible.

The global spillover from US macroeconomic policies
is therefore expected to be positive, but there is some uncertainty beyond
2022.

However, it should be borne in mind that the euro
area’s growth will depend primarily on the path taken by its own policy mix. The euro area should not therefore rely only on
US policy to consolidate and accelerate its recovery. The contrasting fiscal
impulses in 2020 and 2021 between the US and the euro area already indicate a
risk of increasing divergence between the two regions.

We also briefly discuss that the main repercussions from the US may come
not from macroeconomic policies but from financial risks. Asset prices have
risen sharply in 2020, sparking fears of a financial bubble, at least in the
US. This risk could have a significant impact on the euro area in the medium to
long term.