Data released on Thursday showed that the euro area economy expanded by 0.2% in the third quarter of this year, in line with the predictions of Fathom’s Nowcast model. The reading, which was unchanged from the previous quarter and marginally above the average forecast of the Reuters Poll (0.1%), reflected small upside growth surprises in both France and Italy.
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Fathom’s euro area Economic Sentiment Indicator — which distils the information from numerous measures of consumer and business confidence into a single composite measure — has fallen substantially since the start of 2018, driven by a fall in manufacturing sentiment. Although the ESI has shown signs of stabilisation in recent months, it did tick down again at the end of the third quarter. Its current level of 0.2% suggests that growth is unlikely to pick up any time soon. Although a recession in the euro area is not our central case, the natural volatility in GDP growth and a weak underlying trend implies that the odds of a quarterly contraction are high.
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While euro area policymakers may view a growth rate of 0.2% as somewhat of a disappointment, it is broadly in line with Fathom’s estimate of the currency bloc’s trend rate of growth. According to economic theory, in the medium term an economy’s trend growth rate ultimately depends upon increases in underlying productivity and growth in the labour force. On both counts, the outlook for the euro area is far from bright.
On the population front, Eurostat provides projections under a range of assumptions out to 2100. Under the central projection, the population growth rate is expected to slow substantially and even turn negative in the coming years. This is of particular concern for countries such as Germany and Italy, whose populations are projected to have started shrinking by 2049.
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From an economic perspective, it is the fraction of the population available to work — i.e. the labour force — that determines long-run outcomes. Broadly speaking, these are individuals aged 15–64. In the medium term, lower fertility rates and the natural ageing of the population will affect this age group significantly, with the International Labour Organization (ILO) predicting that, for many euro area member states, the labour force will have shrunk substantially by 2030.
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Aggregate output can of course still rise in such a world, but only if the growth rate of productivity outpaces declines in the labour force. Fortunately, while the annual growth rate of euro area labour productivity has turned negative in recent quarters, the underlying trend is still positive, even if it has slowed since the financial crisis. With limited ability to affect population growth in the short run, policymakers’ attention is likely to eventually shift towards boosting productivity as a means to improving growth. Whether this can be achieved, and whether it will be sufficient to offset declining populations, remains to be seen.
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