What if – the eurozone enters a recession

What if – the eurozone enters a recession

December 1, 2022

A menace is haunting Europe - the menace of recession in Europe. If we take the mere technical definition of a recession as a basis – two consecutive quarters of falling GDP – then, by the end of the year, we may be faced with this prospect: the European economy is in recession.

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If this were the case, what next? In this edition of our "What if" series, we analyze the effects of such a recession for the year 2023 – on the development of production and investments, on unemployment, and on consumption.

Figure 1 shows the clear recovery of the European economy following the economic slump caused by the Covid-19 pandemic. By the end of 2021, GDP in the Eurozone was already higher than before the various lockdown measures began. Then came the Russian invasion of Ukraine. This created a serious challenge, especially for those economies in Europe that had relied on cheap supplies of oil and gas from Russia in recent years.

Current forecasts now assume that the European economy will shrink in 2023. By how much will depend primarily on how much gas will be available to the European industrial sector in 2023.

Should the gas supply bottleneck – due to whatever political measures – remain within limits, a moderate decline in the European economy of 0.1 percent can still be assumed for 2023 according to the "Baseline Scenario" by Oxford Economics. However, if the amount of gas available to European industry were to be rationed, Oxford Economics predicts an overall decline in economic growth in the Eurozone of 1.4 percent for 2023.

Now, along the lines of Schumpeter, one might still interpret every economic slump as the beginning of an economic recovery, every crisis as an opportunity for new entrepreneurial creativity. But this interpretation does not take the current crisis seriously enough. A look at the Sentix Survey's Business Cycle Index, which is based primarily on investors' expectations, places the current downturn into a historical context, comparing today's perception of the crisis with, among other things, the crisis triggered by the coronavirus pandemic. The result: the current crisis is perceived by investors and other market participants as more serious as well as deeper than, for example, the Covid-19 crisis. This is probably because a combination of negative factors – scarcity and rising prices of energy, high inflation rates, geopolitical developments – can currently be observed.

What are the specific characteristics of this looming recession? Firstly, a recession has always been accompanied by a decline in production and investment. Figure 2 illustrates this point for the crises of 2008/2009, 2012/2013 and 2020, even if the macroeconomic causes in all three cases – financial crisis, euro crisis, coronavirus crisis – were notably different.

The recession expected for the euro area will also feature its own distinct characteristics: it is likely to hit the European economy in an environment characterized by high inflation rates, rising interest rates, as well as energy supply and geopolitical uncertainties. This distinguishes the present situation from the declines in production and investment in the other three cases mentioned above and leads us to expect that, this time, production and investment could also fall significantly.

It should be noted that although this recession, triggered by higher energy costs, will then affect all sectors, while energy-intensive sectors are likely to be hit comparatively harder as well as faster by possible gas rationing.

What are the likely consequences of the current economic slump regarding the labor market? On this point, a similar comparison of the current situation with the corresponding effects of the financial crisis, the euro crisis and the Covid-19 crisis is informative. If GDP developments in Europe follow the aforementioned "baseline scenario" (compare Figure 1), only a moderate increase in unemployment in Europe can be expected – roughly comparable to the consequences of the coronavirus crisis. However, according to the aforementioned "gas shortage" scenario, there would be a 1.1 per cent increase in the unemployment rate in Europe in 2023.

Remarkably, even in this negative scenario, the impact on the European labor market would be smaller than in 2008/2009 or 2012/2013. This is stems mainly from the fact that the lack of skilled workers in the European labor market is a considerable problem for companies irrespective of the economic cycle; this may come to haunt companies post-recession if it were preceded by redundancies during the crisis. For this reason, among all cost-cutting measures, layoffs appear to be a last resort for companies. For 2023, employers as well as policymakers are more likely to heed those measures that proved their worth during the pandemic, such as short-time work/furlough.

Consumption is also suffering from the gloomy economic outlook. The European Commission's monthly consumer survey indicates a dramatic deterioration regarding the financial situation of European households since the beginning of this year, and it is feared that this development will continue next year, thereby also inhibiting demand from private households.

How can European policy counteract the recession? In crisis situations, European policymakers typically like to rely on publicly financed demand stimulus. But the scope for such measures is limited in an era of high public debt and high inflation rates.

Regarding energy supply, politics also has an important role to play in this crisis. Political measures at national and European level will have a decisive impact on the price and quantity of energy supply and, in turn, also on the extent of the crisis.

In the coming year, the economic situation in Europe appears to be notably tied to developments in the gas market – concerning availability as well as future price developments. Will companies get through the winter well, able to maintain their production volumes at previous levels? Are political measures to combat the gas shortage proving effective? These two concerns will probably determine the duration and intensity of the recession next year.

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What if – the eurozone enters a recession


A menace is haunting Europe - the menace of recession in Europe. If we take the mere technical definition of a recession as a basis – two consecutive quarters of falling GDP – then, by the end of the year, we may be faced with this prospect: the European economy is in recession.

Published December 2022. Available in
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