If you are feeling low, then Olli Rehn, the European commissioner for economic and monetary affairs and the euro, is not the person to cheer you up.

Listening last week (23 February) to his lugubrious presentation of the European Commission’s latest economic forecasts, no one would have guessed that there is quite a lot of good economic news around.

Europe has ducked two potentially crippling economic body-blows in the past few weeks.

A looming funding crisis in the banking system was defused by the decision taken in December by Mario Draghi, the president of the European Central Bank (ECB), to offer banks hundreds of billions of euros on cheap three-year loans.

The second threat was a disorderly Greek sovereign-debt crisis. As Andrew Smithers, one of London’s most erudite economists, puts it, “there is a growing expectation that Greece, which has defaulted recently, will do so again and leave the euro [but] it is no longer assumed that this will cause financial panic or economic weakness in the eurozone” (my emphasis).

Then there is Germany. “There is a positive economic surprise in the making in Germany: the IFO business expectations survey is in boom territory,” says Christian Shulz, senior economist at Berenberg Bank.

A robust German upswing would raise some difficult economic policy puzzles for Berlin. How will Chancellor Angela Merkel’s government respond to emerging labour shortages and rising wage demands? Will she need to start taking fiscal or macro-prudential regulatory action to curb a worrying housing bubble?

And what will the ECB do when faced with another challenge to its one-size-fits-all monetary policy? It can scarcely raise interest rates in the middle of a eurozone slowdown, just because of a recovery in Germany.

But if Germany, which accounts for 27% of the eurozone’s gross domestic product, can lead a Europe-wide recovery, that is very positive news indeed. It helps to explain why Draghi hinted last week, in an interview with the Frankfurter Allgemeine Zeitung newspaper, that the central bank is not about to cut interest rates. He is right, whatever the Americans say.

Ignoring the positives

Rehn, who expects the emerging European recession to be mild, could have accentuated this and other positives. Instead, his presentation last week reflected the excessive reliance of the Commission’s department for economic and monetary affairs on economic modelling. Once again it is underestimating the positive impact on financial-market-driven economies of what John Maynard Keynes called “animal spirits”.

After the unexpected summer slump, these are now on the rise, not just because the banking crisis has been contained, but also because of other good news, including evidence that the always astonishing US economy is on the mend and that financial market pressures on Italy and Spain have eased.

The Organisation for Economic Co-operation and Development (OECD), in its cautious economic survey of Germany that was released last week, highlighted the extraordinary resilience of the German economy since the financial crisis struck in 2007.

Unique among the big Western economies, its unemployment rate has steadily fallen – now down to just under 6%. In contrast to other parts of Europe, output had already recovered to its pre-2007 level by the second quarter of 2011. There was no housing bubble in Germany in the run up to the crash. So neither citizens nor the corporate sector (excluding the big banks) have too much debt. The OECD even raised the possibility that Germany could once again “become a growth locomotive for Europe”.

If this objective is to be achieved over the longer term, however, Germany needs to stop pointing at the inadequacies of its eurozone partners’ economic policies and pay attention to its own. For unless structural frailties are tackled, demographics will condemn Germany to near-stagnation. Germany has one of the worst ageing problems of the world’s top economies.

By 2020, the OECD says, the long-term sustainable growth rate could, because of the shrinking workforce, fall to a paltry 1% – half the rate at the beginning of the century.

A social revolution

The OECD calls for more labour reforms on top of the Hartz IV actions taken a few years ago. It wants policies to promote a social revolution, for that is what getting more women into the labour force amounts to in Germany.

Increasing immigration is not a policy option that will resonate with a socially conservative European nation state. But the OECD says that more immigration is needed, as well as reforms of the upper middle-class professions, the over-protected services sector, and the education system.

It also suggests the promotion of innovation by improving exit opportunities for venture capitalists, a plan that summons up memories of the fiasco of the market for technology shares that closed in 2002.

Quite why Germany is performing so well is no mystery. Those who say it is all down to exports should note, as the Commission does, that last year’s expansion was “mainly driven by domestic demand”. This is in part a positive spillover from what the OECD calls Germany’s “jobs miracle”, which it says others should learn from.

There are plenty of reasons to worry about the economic outlook for the rest of Europe. With the exception of Poland, other big EU countries are still struggling, especially France, Spain, the United Kingdom and – of course – Italy. The battle against government deficits continues and is a contractionary economic force. Banks are still far from healthy: a festering wound that could yet turn very nasty.

Signs of Germany’s rising self-confidence surfaced last week. In an unguarded moment caught on an open microphone, Wolfgang Schäuble, Germany’s staunchly pro-EU finance minister, was overheard reassuring Portugal’s finance minister, Vítor Gaspar, that his country could expect more financial support from the eurozone.

If the Greek crisis is now contained, if firewalls against contagion are being put into place, and if sovereign debtors’ commitments to economic reforms are realised, then the careful sequencing of Germany’s medium-term crisis- management policy could be bearing fruit. The German government could soon be in a strong position to offer more than just verbal reassurances to its troubled eurozone partners.

Stewart Fleming is a freelance journalist basedin London.

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