BLEAK PICTURE FOR THE EUROZONE IN 2012

In 2012 Germany will grow by only 0.6%, France by 0.3% and Spain by 0.3%. Italy is forecast to enter into recession (-0.5%). Greece and Portugal are set for another year of deep recession (-3.2%) and (-3%) respectively. According to the ECB, the Eurozone economy as a whole will grow by -0.4% to 1.0% in 2012 which gives a feeble midpoint of +0.3%.

In addition to the direct effects of the acute fiscal austerity measures, consumers and firms throughout the Eurozone are will be more cautious leading them to postpone consumption and investments. And that's the main issue. Efforts should be undertaken to restore consumer and business confidence.

There will be an increasing tendency to tighten lending terms as well as higher risk premiums on loans to households and firms further inhibiting gowth in demand.

The cuts in government spending and higher taxes will lead to lower aggregate demand and lower economic growth. As a result of the fall in output, firms will employ less workers leading to higher unemployment. Also, government spending cuts may involve making public sector workers redundant. Fears over job losses, and expectations of lower growth will encourage consumers to save rather than spend. This will be a further drag on consumer spending and economic growth.

Certainly higher taxes and lower spending will lead to an improvement in the governments' budget deficits in the Eurozone and this will improve public finances in the long term. However, given that austerity measures will cause lower economic growth, governments will also see a fall in income tax revenues as less people will be working. Since austerity measures will cause unemployment, it will require higher government spending on benefits.

Austerity is not as damaging if a country can devalue the exchange rate. This devaluation helps to restore competitiveness much quicker than relying on internal devaluation (case where a country seeks to regain competitiveness through lowering wage cost and increasing productivity and not reducing value of exchange rate). The depreciation helps boot export demand. Countries in the Eurozone, however, can't devalue and so have to rely solely on internal devaluation to restore compeitiveness.

Austerity is not as damaging if the rest of the world economy is doing well. If global growth is strong, export demand will be strong. However, if all countries are experiencing a recession, then deflationary fiscal policy will have a greater impact in reducing domestic demand.

The recent meeting in Brussels aims to tackle the eurozone's debt crisis through a tax and budget pact. The main features agreed to as part of the new agreement called the fiscal compact include:

• A cap of 0.5% of GDP on countries' annual structural deficits
• "Automatic consequences" for countries whose public deficit exceeds 3% of GDP
• The tighter rules to be enshrined in countries' consitutions
• European Stability Mechanism (ESM) to be accelerated and brought into force in July 2012
• Adequacy of 500 bn-euro limit for ESM to be reassessed
• Eurozone and other EU countries to provide up to 200 bn euros to the IMF to help debt-stricken eurozone members.

Collective measures to restore consumer and business confidence and further economic growth to avoid the continent getting into recession were hélas not on the menu.