Global Monthly - This is getting complicated

Global View: The story of a resilient US and a weak eurozone is no longer clear-cut

For a time, the overall outlook – if not the details – was somewhat clear: the US would hit its trade partners with punitive tariffs, but because of offsetting factors in the US (deregulation and tax cuts), the growth shock for others would be larger. All of this would trigger a massive monetary policy divergence, with tight monetary policy in the US to fight tariff-induced inflation, and looser policy elsewhere to cushion the trade and growth shock. In the past month, this picture has muddied considerably. First, it has become increasingly clear that the US will be hit hard by its own tariff policy (something we long expected), while offsetting factors – such as the deregulation drive – seem to have lost momentum. This has knocked confidence, raising fears of a US recession. As described in our US outlook, the current weakness suggested by nowcasts is driven by a frontloading of imports, and is therefore a red herring. However, there are other reasons to believe recession risk is real and this is likely what has caused a renewed pricing in of Fed rate cuts. The second factor muddying the outlook is Germany’s new fiscal bazooka, and more broadly European defence spending. While we are sceptical about the capacity of some key eurozone countries to increase deficits, Germany’s new fiscal firepower and the EU’s new SAFE fund could by itself be a sufficient game changer for next year’s growth outlook. That is, as long as US tariffs – and their economic impact – do not get out of hand. To know this, we are waiting with bated breath for the US administration’s fabled 2 April announcement, which could well portend much bigger tariff rises than we have currently incorporated into our base case. It is this key uncertainty that makes us refrain from raising our eurozone growth forecasts on the back of higher fiscal spending. For now, we have provided estimates for the likely impact of defence and German infrastructure spending, but we plan to do a full review of our base case when the US’s tariff plans have been revealed. One thing is clear: the outlook is getting a lot more complicated.

Spotlight: The Mar-a-Lago accord

Rogier Quaedvlieg - Senior Economist US

• The proposed Mar-a-Lago accord aims to devalue the dollar by coordinating international efforts, similar to the 1985 Plaza Accord, in an effort to address perceived trade imbalances caused by the dollar's reserve currency status.

• Countries are unlikely to sign up voluntarily, and the proposed tactic of tying it to tariff reduction and defence support is becoming increasingly infeasible as the administration has already shown their hand

• Mainstream economic theory favours fiscal tightening as a more effective approach to address trade deficits and currency depreciation. The current proposal is inflationary and dampens growth.

This Spotlight summarises our note Tariffs are not the endgame

In 1985, US officials met with G5 countries at the Plaza Hotel to negotiate a coordinated intervention to devalue the dollar. Recently, the idea of a 'Mar-a-Lago' accord, named after the President's Florida resort, has been gaining attention as part of a plan to devalue the dollar and reshape global trade. This new approach to trade focuses on distortions causing trade imbalances. Council of Economic Advisers Chair Stephen Miran elaborates on this perspective in "A user's guide to restructuring the global trading system," where he outlines what he thinks are structural problems facing the US and suggests policies linking trade, financial flows, and defence to address them.

The Mar-a-Lago accord is best understood in this broader context. The fundamental idea is that the dollar is overvalued due to its status as a reserve currency, which impedes balancing international trade. This overvaluation is believed to have hollowed out America's manufacturing and tradeable sectors. Tariffs are seen as a tool to rebalance trade, attract investment to the US, and rebuild industrial capacity, particularly in strategic sectors. However, the inevitable appreciation of the dollar could undo these efforts. The proposed solution is a Mar-a-Lago accord, similar to the Plaza accord, where countries would collaborate to weaken the dollar while maintaining its reserve status. Participation would be encouraged through incentives and penalties in the forms of (withdrawal of) tariffs and defence support depending on their willingness to align with US geo-economic objectives.

Miran's perspective on the global economy is rooted in a theory advocating for more balanced trade at the country level, arguing that large deficits arise from government policies, especially in surplus countries, and harm deficit countries. The view is debatable, as many countries have sustained high trade deficits without issue, particularly when capital flows are unrestricted. Miran sees the root cause in the dollar's overvaluation and links it to its reserve currency status, which allegedly forces the US to maintain a deficit as foreign entities hold dollars as reserves. These ideas echo Triffin's theory from 1960, where a reserve currency necessitates current account deficits until debt accumulation threatens its status. The dollar's value is of course influenced by various factors beyond reserve status. Indeed, the US's current account deficit exceeds IMF estimates of a sustainable level, driven by public and private sector spending rather than the dollar's strength. The proposed solution involves a Mar-a-Lago Accord, where countries would sell dollars and short-term treasuries and increase the duration of remaining holdings to stabilize long-term yields and preserve the dollar's reserve status.

It will not be easy to convince trading partners to devalue the dollar. Key players like the Eurozone and China, are not in a position to reduce their competitiveness. Tariffs and defence support are earmarked as leverage in negotiations, but their threats have lost considerable power over the past month, with any defence commitment lacking credibility after removing Ukraine support and threatening to leave NATO, and tariffs losing impact by being wielded in broad and uncoordinated ways, with many cancelations and delays. The fact that tariffs were applied to Mexico and Canada, the US’ close USMCA partners highlights that any deal is not worth much. Pursuing this strategy would greatly hurt the dollar’s reputation, but its reserve status is likely to persist in the near-term due to the lack of alternatives, despite broader pressures on its dominance.

Mainstream economic theory would suggest fiscal tightening as a more effective method to reduce the trade deficit and depreciate the dollar, primarily through a demand channel. Coincidentally, recent data suggests a weakening US economy due to tariff-related recession fears, while Europe and China are expanding fiscal policies. These business cycle developments have already played a part in a modest depreciation. In the longer-term, empirical evidence on the new trade theory is limited, and the evidence there is, is not directly supportive. Any long-term benefits are therefore unclear, while short-term adverse effects, in terms of inflation and growth, are much more certain.

Spotlight: Can defence spending revitalise the eurozone economy?

Bill Diviney, Senior Eurozone EconomistAggie van Huisseling – Netherlands Economist

• Higher defence spending will likely significantly lift growth in 2026, in both the eurozone and the Netherlands

• A lot will depend on how quickly spending ramps up, and the extent to which Europe can re-tool industry

• All else equal, this is likely to mean the ECB cutting interest rates less than we currently expect

This Spotlight summarises our note Can defence spending revitalise the eurozone economy?

The confluence of Germany’s federal elections and the US pulling back from the decades-long transatlantic alliance is fomenting a revolution in European defence spending. Germany is abandoning fiscal frugality in the face of an existential threat to Europe’s independence and security, while the EU is likely to significantly loosen the fiscal rules, supported by c0.8% of GDP in new common debt financing. In this note, we explore the potential impact of these changes for the near-term growth outlook. In the very near-term – at least for this year – the impact is expected to be small, but the fiscal boost could be potentially game-changing for 2026 and beyond. In a reasonable middle ground scenario, we think 2026 growth in the eurozone could be lifted by 0.3pp, or 0.4-0.5pp when including Germany’s infrastructure spending plans. In a downside scenario, the boost would be only 0.1pp, but in a more optimistic scenario the impact could be as high as 0.8pp. Beyond the near term, the academic literature suggests that structurally higher defence spending can have major spillover effects to long-term productivity, thereby lifting potential growth – by 0.25% for every 1% of GDP spending increase. In short, while raising defence spending is initially costly, it can potentially pay for itself over the longer run.

All else equal, this boost to growth would be enough to see the ECB cutting interest rates less than we currently expect, with the deposit rate settling at, say, 1.5% instead of our current 1% expectation. But with potentially much more aggressive US import tariffs expected to be announced on 2 April, which poses major downside risks to the outlook, we refrain for now from making a formal change to our base case.

The potential impact on eurozone GDP growth varies with defence spending scenarios. Achieving military independence from the US requires spending to rise to around 3.5% of GDP, aligning with the European Commission's implicit target. However, this goal appears to be a long-term aspiration rather than an immediate possibility. Some member states, like Italy and France, lack the fiscal capacity to increase spending without negative impacts, while others, such as Spain, do not share the same urgency due to their distance from Ukraine's frontline.

A feasible near-term target is estimated at 2.7% of GDP by 2026, assuming Germany fully utilizes its new fiscal firepower, with fiscally-challenged countries accessing the EU's new €150 billion SAFE common debt instrument. The growth impact hinges on the fiscal multiplier, which varies based on spending type, the degree of slack in the economy, and import intensity. Academic literature focused on the US suggests a multiplier range of 0.6-1.0, potentially higher in the long run due to productivity growth spillovers. But initially, the multiplier is likely to be lower than this range suggests, around 0.2-0.3, because much of current defence spending is highly import intensive. The fiscal multiplier will also depend on the degree of slack in the economy. European industry, particularly in Germany, has significant spare capacity. Unemployment in Germany has risen to a near 5-year high of 6.2%, with capacity utilisation in the manufacturing sector at recession-like levels. There is uncertainty over how quickly spare capacity can be re-tooled for the production of defence equipment. The quicker the re-tooling of the economy takes place, the lower the reliance on imports, and the bigger the impact on the multiplier and therefore on growth.

Impact on the Dutch economy

According to official NATO data, the Netherlands met its 2% defence spending target in 2024, but an upward revision to GDP caused actual spending to dip below 2%. The coalition aims to meet the target by structurally raising the defence budget. However, with a projected €22bn budget in 2025, spending will only reach 1.87% of GDP. A tight labour market has led to underspending, creating uncertainty about future increases. The expansion goal for defence personnel fell short due to limited training capacity. Moreover, much of recent defence procurement happened outside the EU and the Netherlands is particularly reliant on the US. Due to limited slack in the economy (as illustrated by the positive output gap) and the tight labour market, we assume a lower multiplier, gradually rising to 0.5 as industrial defence capacity increases over time. Political division and labour constraints suggest defence spending is more likely to rise to 2.5% of GDP by 2026, rather than the Commission’s implicit 3.5% goal. Combined with our assumption of a gradually rising multiplier, this would lift our 2026 growth forecast by 0.2pp to 1.2%.