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2019-10-04Macro `n Cheese

A Bet on Europe is a Bet on the World

If you feel our in-house economist has focused a lot on the European economy over the past few weeks, you’re absolutely right. Today, he explains why and concludes his exposé with a sobering view on the outlook for the Euro Area.

En Attendant Godot

I have used the name of the Samuel Beckett-play as a theme for presentations and articles so many times over the past few years that I really thought I would never ever want to use it again. However, looking back, I see that I have exclusively used the ‘Waiting for Godot’ theme when analyzing the European economy in one way or another.

And preparing for an upcoming presentation on the Euro Area over the past few weeks, I have actually felt a bit like Vladimir in the play, constantly reminding Estragon (that’s you dear reader) of how futile it is to put your hopes on European fiscal stimuli appearing (that’s Godot for you!). So I guess it is OK to use the “waiting-for-Godot”-theme just this one last (!) time.

This is, in short, a piece of what I think should be the main scenario: Europe develops in line with global demand.

A European revival

In the chart below I have used the PCA-analysis to create a proxy for external demand in a number of economies, including the Euro Area, based on the world’s major economies. Now, just to show that it’s not too shabby a technique, see what happens when I plot the first principal component, PC(1), of GDP-growth in the worlds’s major economies against a more rigorous measure of world GDP-growth (from OECD):


Of course, the levels are not directly comparable, but you can normalize the PC(1) with the mean and variance of world GDP-growth if you feel inspired. The important thing, nonetheless, is that we can conclude that world GDP-growth and the first principal component show more or less the same developments over time. Thus, I should be able to use this technique to create an estimate of external growth for all major economies, by simply excluding them one by one and re-calculating the PC1. For the Euro Area, it looks something like this:


Euro Area external growth seems somewhat less volatile and with a less obvious downward trend than what the equivalent world aggregate suggests[1].

Having done that same operation for a few more countries we can start to compare how sensitive each country is to its respective external growth proxy:

[1] Admittedly, the first is probably an artefact of the second and raises some questions on our usage of the Principal Components Analysis.


The beta for the Euro Area is quite high (albeit below 1) in comparison to the US and Japan, for example, implying that the European economy is more sensitive to external developments than either of the other two large developed economies.

Also, when looking at the lag-structure, we notice that in comparison to the US, which also has a high (well, higher than Japan, at least) sensitivity, we can notice that the US (and Japan too) tends to lead the rest of the world, and the Euro Area is a laggard. This can be due to a host of explanations, of course, but an often faltering policy response from both Euro Area monetary (at least pre-Draghi) and fiscal policy does come to mind.


So, in the end, if you, like me, see little reason to believe that European fiscal policy makers will rise to Draghi’s call to arms, all the evidence is that Europe – despite being one of the world’s largest economies – will continue to behave like the small, open economies from which it is constructed.

I genuinely hope that I’m wrong, but if you bet on the revival of Europe, you’d do well to remember that for all we know, it is rather a bet on the revival of the world economy.


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We don’t usually have views and opinions about economic and financial states of affairs, (not ones that we express publicly as a company, anyway). We do believe, however, that people can and do appreciate a variety of perspectives. What you’ve just read is the perspective of our resident chief economist. While we think he’s very smart, Macrobond Financial does not expressly endorse the views he presents here. And, as the old adage goes, you shouldn’t believe everything you read (not without finding the data, performing a few analyses and presenting it in a nice chart). We want to make it clear that we are not offering this information as investment advice. That being said, if you have the application you can easily check everything that’s mentioned here, and decide for yourself. If you don’t have the application, now you have a great reason to get it.