As the global economy is hit by the energy crisis, distortions of supply chains, and the consequent inflation, the possibility of a global recession is becoming increasingly inevitable. Europe is no exception to that. Increasing prices and the issue of surviving the winter without Russian natural gas are contributing to the expectations of a recession.
A recession is usually defined as two consecutive years of GDP decline. The definition is first created by Julius Shishkin in a 1974 New York Times article and has been a popular indicator of recession. According to this definition, the world’s largest economy, the United States, is already in a recession, as the US economy contracted for two quarters in a row. As for the Eurozone, economists say a Eurozone recession is now more likely than not. The same concerns are also valid for China, which experiences slowing growth rates and missed a second-quarter contraction because of Xi Jinping’s zero-Covid policy and other problems.
Another accepted definition is created by The National Bureau of Economic Research (NBER), which characterizes a recession as a significant decline in economic activity that is spread across the economy and lasts more than a few months. This is a more flexible definition, but the probability of a significant decline in economic activity spreading across the economy and lasting more than a few months’ still persists for Europe, considering that the global economy is in bad shape and Russia is weaponizing its natural gas exports to Europe.
One expectation became true last Friday. Following the G7 countries agreeing to introduce a price cap on Russian oil exports, Russia’s state-owned Gazprom halted the flow of the Nord Stream 1 pipeline indefinitely due to “an oil leak discovered in the main gas turbine at the Portovaya compressor station near St Petersburg, which feeds the line that runs through the Baltic Sea to Germany.” Whether Russia would restart the flows of natural gas through Nord Stream 1 or not, it is essential for Europe to be ready for the worst. Recently, International Monetary Fund (IMF) prepared a forecast as to how the potential effects of a full and immediate suspension of natural gas supplies would hit the European economies. The EU is expected to lose 1.8 percentage points in GDP growth compared to the ongoing course before the gas suspension decision last Friday.
On the supply side, German companies already started to halt production in response to soaring energy prices before the latest gas suspension. As the head of The Federation of German Industries (BDI), Siegfried Russwurm, said, the price of electricity for 2023 had risen to more than €700 per megawatt hour. There are problems on the demand side too. Producers complain about the decrease in the quantity of goods demanded and consequently rising inventories. A decrease on both sides of macroeconomic activity is quintessential to a recession.
What can the EU do next?
The European Commission released a decision on May 18 named ‘REPowerEU,’ which aims to rapidly reduce Russian fossil fuel imports with other sources of energy and fast-forward the green transition. The plan targets replacing two-thirds of energy coming from Russian fossil fuels. Other than diversifying the energy sources, there are only limited solutions that might harm the economy.
One solution is to have 85% of natural gas storage full ahead of the incoming winter heating season. The European Union (EU) countries are going at a good pace in fulfilling this target. To cope with the limited energy supply and high prices, another solution is to curb the demand for energy. This solution was put forward on the same day as the REPowerEU plan by the European Commission via ‘EU Save Energy Communication.’ With behavioral changes, this decision expects to cut gas and oil demand by 5%. The EU countries have already begun to take necessary measures expressed in EU Save Energy Communication and apply additional adjustments.
These measures are necessary to survive the winter but are also inevitably contributors to a recession. The EU policymakers should continue their efforts to diversify the sources of energy. The incoming recession might decrease energy prices in winter, but it is also important to remember that the incoming global recession is mainly rooted in the supply side. In this situation, it is unlikely to experience sharp falls in energy prices. Therefore, the severity of the energy crisis stands firm.
As more and more signs of a recession show up, European countries and European Central Bank (ECB) should make decisions in accordance with this very high possibility. The ECB and the EU governments had been reluctant to respond to the rising inflation for months, but the energy crisis showed that putting emphasis on inflation is essential to cope with the challenges posed by Russia’s energy weapon in winter.