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Europe will experience a deeper recession than the United States

by archyde

It is much more difficult to organize a soft landing for the economy if the potential supply of goods and services has been destroyed or no longer reacts to rising prices.

Following the fallout from the war in Ukraine, it is almost certain that Europe will experience a deeper recession than the United States. The UK economy also looks particularly vulnerable due to its close trade links with Europe and its more general reliance on energy and electricity imports. Despite this, interest rates in both the Eurozone and the UK are likely to end up being much higher than would be expected for economies with neutral policy and potential growth rates are weak.

It is much more difficult to organize a soft landing for the economy if the potential supply of goods and services has been destroyed or no longer reacts to rising prices. The ECB and the BoE seem to have no choice but to aggravate the energy shock on production by destroying demand even more. Fiscal stimulus measures and depreciating currencies make the task all the more difficult. And that is, centrally, why monetary policy could end up being much tighter in the UK and the Eurozone than in the US.

In a world of great abundance before the pandemic, supply was rarely a limiting factor to growth or a driver of inflation. Today, as a consequence of the pandemic and the war, supply constraints have not only become a major factor of inflation, but also a major differentiating factor between countries. While Europe will almost certainly suffer a more severe growth shock than the US, it is entirely possible that the destination of monetary policies, and therefore interest rates, will be similar in absolute terms. When supply rules, the old rules of monetary policy may no longer apply.

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