Economics Group MONTHLY OUTLOOK February 10, 2010

Sovereign Debt Concerns in Southern Europe

In response to market concerns over its indebtedness, the Greek government has proposed an ambitious fiscal adjustment plan over the next few years. In order to help stabilize the government’s debt-to-GDP ratio, however, nominal GDP growth in Greece needs to rebound. But the common currency that Greece shares with the other members of the euro area precludes strong export growth via real exchange rate depreciation, which will hamper its ability to achieve strong growth in nominal GDP. In our view, there is a significant probability that Greece will need financial support from the European Union (EU) and/or the IMF to help the government smooth out its fiscal adjustment. The fiscal situations in both Portugal and Spain are not as dire as they are in the Hellenic Republic, but these two countries may also need financial support if investors remain spooked.

Growth Is Not Nearly as Strong Beneath the Surface

Expectations for near-term growth have been ratcheted up, following the fourth quarter’s robust 5.7 percent real GDP growth. While that number came in almost precisely in line with our forecast, we have raised our estimate for first quarter growth and slightly reduced our expectations for growth during the second and third quarters. The adjustments were necessary because inventories are correcting much more quickly than originally thought. Inventories added 3.4 percentage points to fourth quarter GDP growth and are expected to add another 1.2 percentage points to growth during the first quarter.


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