Vanessa Rossi
(Former Chatham House Expert)

L'Aquila G8 is the first summit to take place since the Eurozone economic outlook was radically downgraded to reveal that its performance will be worse than the US and probably also the UK. This is chiefly because the German government finally admitted just after G20 that its recession will be similar to Japan's and far deeper than other G20 states except Russia. The Eurozone in general persisted for too long in the belief that its economy could remain relatively immune to the escalating crisis, a view that clearly proved not only wrong but dangerous. This led to errors that distorted analysis, damaged global relations and policy coordination and exacerbated risks. Can there now be as dramatic a shift in Europe's approach to assessing risks and addressing problems as there has been in its economic forecasts?

Recent data shows just how poorly the European economy is performing, with the fall in Eurozone output actually getting worse rather than flattening off, much of emerging Europe effectively bankrupt and reliant on bail outs and unemployment increasing sharply in spite of efforts to suppress it. This is leading to rising social pressures and voter discontent, putting pressure on the concept of EU integration. The situation needs urgent attention but this is unlikely before the German elections in September - and uncertain even after this event.

Banking risks also remain substantial and need to be treated more transparently and rigorously. The ECB has just provided another huge sum to help suppress interest rate spreads and offset the continued reluctance to resume interbank lending - at more than 440 billion euro, this is even larger than the previous record set in late 2007. But it is not clear if this new money should be seen as a final solution to the credit crunch or a cause for fresh concern about the underlying shaky position of the European banking system. Is the ECB simply papering over cracks that will resurface after the summer holidays (and German elections)? Events of the last two years have made everyone extremely cautious if not outright cynical on this score.

Certainly there are too many downside risks for comfort. Sobering assessments by European analysts point to the probability of permanent downgrades to the level of potential output (GDP) for the EU economies, possibly suggesting that GDP could fail to recover its past peak over the next decade. Growth aspirations, low at the best of times, have slipped further and this will inevitably impact on the outlook for industry restructuring and jobs. Given Europe's interconnectedness, this will set in train further negative feedback effects that will spread and escalate the damage around the continent.

Almost certainly, lower estimates for potential GDP will encourage even greater concern about future inflation risks and escalating government debt. Talk of 'exit strategies' may actually imply not just planning but an imminent intent to exit from easy policy. There are clearly simmering differences of opinion in Europe, and in G8, about the appropriate policies to pursue at this point and the risks linked to premature tightening. Alternative strategies need to be examined urgently and carefully.

Decisions could turn on the view of the next German government but, in the meantime, the G8 summit could serve as an important forum for opening up discussion of the key issues, many of which are common to all the G8 participants. The threats identified do impact on the global economy as well as in Europe and the policies adopted will make a difference to final outcomes.

The views expressed in this commentary are treated in more detail in a briefing paper by Vanessa Rossi, Towards a Post-Crisis Global Economy: Not out of the Woods yet, Europe now the Key Risk?, July 2009.