Can the Euro Area Avoid a “Lost Decade”?

A “lost decade” refers to an extended period of low or negative growth triggered by an economic crisis and that could have been avoided by the use of efficient crisis policies. The risk to the world’s developed economies of a lost decade was highlighted early on in the 2007-2008 crisis. Now, five years on from the severe recession of 2009, the risk appears much more of a concern for the Euro Area. We find that there is currently a moderate to high risk of production capacities in the Euro Area being permanently impaired. The risk relates mostly to the prolonged period of stalled investment and persistent unemployment, with its detrimental effect on human capital. In addition, paying off past debt will be painful to both the public and private sectors, in particular in the context of a low inflation environment. The policy response in the Euro Area has been hesitant. It emphasised structural reforms over cyclical policies. While structural reforms are a good lever for growth in the long term, they need to be accompanied by much stronger cyclical policies, especially given the recessionary environment. In short, there is a danger the decade could be lost because of an excess of confidence in the ability to fight a major economic crisis with structural reforms only.