US Protectionism and the Risks for the Euro Area
The global economic landscape is shifting rapidly, with protectionist policies from the United States posing significant challenges for the euro area. A new study, Euro Area Risks Amid US Protectionism, prepared by a panel of economic scholars from leading institutions, among which Carlo Favero, Francesco Giavazzi, and Tommaso Monacelli, all affiliated with Bocconi University and IGIER, with Laura Bottazzi (Bologna University and IGIER member) and the Bocconi PhD student Ruben Fernandez-Fuertes, examines the repercussions of US protectionist measures on the euro area, highlighting both direct effects, such as tariff-induced trade disruptions, and indirect consequences, including financial contagion and shifting exchange rate dynamics. With a strong focus on policy responses, the report offers strategic insights on trade diversification, innovation incentives, and prudent monetary policies to navigate this uncertain terrain.
The study was coordinated by the Economic Governance and EMU Scrutiny Unit (EGOV), which provides external expertise to the Committee on Economic and Monetary Affairs on policy issues in the field of monetary and economic affairs.
Key findings
The panel stresses that while direct tariff effects may be mitigated by exchange rate adjustments and monetary policies, broader risks arise from financial market spillovers and global trade disruptions. US-imposed tariffs on European goods could initially lead to some contraction in EU exports. However, a depreciation of the euro could help offset some of these effects, preserving European competitiveness. Higher risk premiums on long-term US bonds may increase European financing costs, posing challenges for fiscal sustainability and private sector investment. As US protectionist measures target China, surplus Chinese exports may be redirected toward Europe, intensifying competition and affecting key European industries.
The report, in short, emphasizes the importance of avoiding reactionary protectionism in Europe. Instead, it advocates for strategic trade diversification, investment in technological innovation, and coordinated fiscal-monetary responses to mitigate potential economic slowdowns.
Policy recommendations
To address the challenges posed by US protectionism, the study outlines a number of strategic policy recommendations. Trade diversification should be a priority, with the EU actively seeking to expand economic partnerships beyond traditional markets. Strengthening commercial ties with regions like Latin America, Africa, and Southeast Asia can help reduce the risks associated with trade dependency.
Innovation and investment incentives must be enhanced to ensure that European industries remain competitive. Policies encouraging research and development, particularly in high-tech and green sectors, can drive sustainable economic growth.
On the monetary front, the study recommends that the European Central Bank (ECB) maintain a flexible approach to monetary policy, allowing for exchange rate adjustments that can cushion the impact of trade restrictions. The ECB should avoid premature tightening in response to inflationary pressures stemming from import price increases and instead focus on stabilizing growth and employment in the euro area.
Fiscal coordination at the EU level is also crucial. Member states should align their fiscal policies to support economic stability, avoiding abrupt spending cuts that could deepen economic slowdowns. Targeted stimulus measures, including investments in infrastructure, can provide long-term economic benefits while counteracting protectionist disruptions.
A measured and diplomatic approach to trade policy is vital. Rather than responding with retaliatory tariffs that could exacerbate economic instability, the EU should work within international trade frameworks to negotiate favorable trade terms and resolve disputes. Strengthening multilateral trade agreements and reinforcing the EU’s commitment to open markets will help position the euro area as a stabilizing force in the global economy.
Implications for European policymakers
With the ECB and EU policymakers facing higher uncertainty, the study suggests that a cautious yet proactive approach is necessary. Rather than mirroring US protectionism, Europe should reinforce its position as a global trade leader, strengthen economic partnerships, and ensure financial market stability through targeted policy measures.
