Economic developments in the euro area and the United States in 2020

Prepared by Malin Andersson, Cristina Checherita-Westphal, Ramon Gomez-Salvador, Lukas Henkel and Matthias Mohr

Published as part of the ECB Economic Bulletin, Issue 2/2021.

The coronavirus (COVID-19) pandemic has profoundly affected both Europe and the United States. Despite the pandemic reaching the United States later than the euro area and US population density being lower, the number of new COVID-19 cases has generally been higher in the United States than in the euro area, particularly so from mid-November 2020 to the end of February 2021. This higher incidence of infection in the United States may reflect the effectiveness of lockdown policies as measured by Goldman Sachs’ Effective Lockdown Index (ELI) (Chart A).^[1] To the extent that the United States was subject to fewer restrictions than the euro area, the short-term responsiveness of the economy to policy stimulus was also likely greater. Against this background, the box compares economic developments in the euro area and the United States, focusing on 2020.

In 2020 real GDP declined more in the euro area than in the United States, possibly related to several factors. While the more severe lockdowns in the euro area have likely been an important factor behind this stronger decline in GDP, differences may also relate, inter alia, to different economic structures, growth potential and policy responses, as well as the timing of the pandemic waves. The cumulative activity loss in the fourth quarter of 2020, compared with pre-crisis levels, amounted to 4.9% in the euro area and 2.4% in the United States (Chart B). In both regions, based on 2019 figures, about three-quarters of real value added was related to the adversely affected services sector, while only 15% and 11%, in the euro area and the United States respectively, stemmed from the manufacturing sector. Across demand components, private consumption contributed to GDP by broadly similar amounts in the two regions throughout the year, despite almost twice as much income support being provided in the United States (Chart C). This suggests that the smaller-sized but more targeted policies in the euro area (i.e. through short-time work schemes) might have been effective in cushioning an even larger fall in consumption. In the first two quarters of 2020, euro area firms postponed their investment plans to a larger extent than US firms, the euro area corporates appearing to be more sensitive to increasing uncertainty, falling demand and reduced profits. In contrast, the euro area saw a stronger cumulated rebound in investment in the second half of the year. Exports were more adversely affected in the euro area in the first half of 2020 owing to the economy’s exposure to China and Eastern Europe, while the United States was more negatively impacted by weak foreign demand from Canada and Latin America in the first half of the year, and from the euro area (and the rest of Europe) thereafter. Overall, the net trade contributions were more subdued in the United States than in the euro area.

In 2020 the discretionary fiscal policy response to the COVID-19 crisis was very substantial in both the euro area and the United States, although the response in the latter was stronger (Chart C). In the euro area, the fiscal response to the pandemic consisted mainly of subsidies and transfers to firms and households, including job retention schemes.^[2] Support to households and firms was also the main driver in US fiscal policy, particularly via direct transfers and unemployment benefits. Government consumption growth was higher in the United States than in the euro area and included a larger increase in health-related expenditure. Overall, while consistent data comparisons are difficult, the discretionary component of the fiscal response to the pandemic is estimated to have amounted to about 4¼% of GDP in the euro area and about 7¾% of GDP in the United States.

If the impact of automatic stabilisers is included, the total fiscal impulse in the euro area in 2020 comes closer to the equivalent impulse in the United States. Automatic stabilisers – proxied as the change in the cyclical component and other factors – are assessed to have been larger in the euro area.^[3] Together with the discretionary measures, their fiscal impact amounts to close to 7% of GDP in the euro area compared with around 10% of GDP in the United States. This total fiscal impulse, or broadly speaking the budget balance cost of the pandemic, corresponds to the estimated change in the primary balance from 2019 to 2020. Caveats to these comparisons stem from the lack of fully consistent data, the timing of the forecast and the assessment methods used, as well as the unavailability of the final budget execution for 2020.

Additional liquidity support was provided in both the euro area and the United States. Governments extended various forms of liquidity support to firms, which in the euro area consisted of guarantees for loans within a total envelope of 17% of the combined GDP of member countries (5.7% in the United States).^[4] Other liquidity support measures in the euro area took the form of substantial tax deferral schemes and capital injections.

The monetary policy reaction was significant but stronger in the United States than in the euro area. In terms of the monetary policy reaction, while both the ECB and the US Federal Reserve System responded forcefully to the pandemic shock, the decline in the federal funds rate from 1.50-1.75% to 0-0.25% and the depreciation of the US dollar provided additional stimulus in the United States.

In the euro area the substantial increase in employed workers covered by job retention schemes left the unemployment rate broadly unchanged, while in the United States those layoffs that were temporary in nature caused the US unemployment rate to rise (Chart D).^[5] The euro area would have recorded a much larger decline in employment had all workers subject to job retention schemes, as indicated by the yellow portion of the bars in Chart D, become unemployed or inactive. These schemes prevented unemployment and inactivity in the euro area from increasing by amounts comparable to those observed in the United States. By the end of the fourth quarter of 2020, employment in the euro area was 1.9% below its level for the fourth quarter of 2019, while in the United States it had fallen by 5.5% over the same period, as recourse to job retention schemes in the euro area increased again with new lockdowns and the US employment recovery slowed.^[6] Recourse to job retention schemes in the euro area implied a stronger adjustment through average hours worked.

During the pandemic, the rates of both headline and underlying inflation have declined strongly in the euro area and the United States due to falling oil prices and a significant drop in demand. Underlying inflation in the United States fell more quickly in the first half of the year before increasing moderately thereafter, while in the euro area it declined moderately at first and was further subdued in the second half of the year, partly on account of the temporary VAT reduction in Germany (Chart E). In both the euro area and the United States, the decrease in underlying inflation is mainly attributed to items that are adversely impacted by social distancing. The most severely hit items include travel-related/transportation services and clothing and footwear/apparel.^[7] While the inflationary contribution from other goods was positive in the United States, they were negative in the euro area (Chart E).^[8] When correcting for the impact of the German VAT reduction, the fall in the Harmonised Index of Consumer Prices excluding energy and food (HICPX) in the euro area in the second half of 2020 would have been less pronounced but still significantly below pre-pandemic levels^[9].

In conclusion, more stringent pandemic-related measures and, to some extent, the lower level of fiscal support in the euro area than in the United States may have contributed to the different economic outcomes. Inflation was more subdued in the euro area, also on account of special factors like the temporary reduction in German VAT. Euro area policies appear to have been more supportive of employment, while in the United States the focus was on broader income policies.