Volatility in Dutch economy harms well-being

Macroeconomic volatility undermines general well-being

Research shows that the distress most people experience from a recession is twice as high as the satisfaction they derive from an economic boom phase. Compared with a stable economy, a volatile economy not only has higher peaks, but also deeper troughs, which can have dire consequences for the labour market, as it leads to unemployment and dismissals. As many people derive their identity from their jobs, becoming unemployed makes them unhappier. Another study shows that the impact of dismissal on a person's happiness is more lasting and more profound than many other events in life, such as divorce or the death of a loved one. This is why it is desirable to reduce volatility, in other words the boom and bust cycle in the economy.

Volatility comparison against appropriate reference group 

Compared with the rest of the euro area, volatility in the Dutch economy in terms of GDP growth would not appear to show a very prominent boom and bust cycle. Measured by the standard deviation (a measure of volatility), the Dutch economy is found to be slightly more volatile, but the difference is not remarkable: 2.0 percentage points for the Netherlands, against 1.7 percentage points for the rest of the euro area. Such a comparison, however, provides a distorted picture, because it sets the Netherlands against countries that do not resemble it in terms of economic structure (openness, industry sector distribution and wealth level), such as those in southern Europe. A more appropriate exercise, therefore, is to compare volatility in the Dutch economy against that in economies of countries which are similar in these respects, also known as peers. Based on similarities in terms of economic structure, Belgium, Austria and Denmark can be considered such peers. Figure 1 shows that the Dutch economy tends to have higher peaks and deeper troughs than these countries. This finding does not change if Germany and France, which do not have small, open economies, but are important trading partners and have similar institutions, are added to the peer group.

Chart Dutch GDP growth set against various groups of countries
Annual percentage changes

Source: Eurostat, DNB calculations

The Dutch real economy and financial sector interact closely

What makes the Dutch economy more volatile than those of our peers? The close interaction between the real economy and the financial sector is a major factor. For example, Dutch households face higher than average liquidity constraints compared with peers, as most of their assets are comprised of illiquid pension savings and investments in owner-occupied homes. As a result, only 30% of the average financial assets of Dutch households are liquid, whereas, for example, for Belgian households this is 75%. Dutch nationals are therefore limited in their ability to use their assets to absorb shocks. This means that these shocks have an almost complete impact on consumption. As a result, volatility in private consumption strongly contributes to the erratic movements in the Dutch economy. On top of this, volatility in the Dutch housing market exacerbates the erratic consumption pattern. This is because the Netherlands’ high mortgage indebtedness causes house price movements to have a relatively large impact on consumption. Lastly, the Dutch government's past procyclical fiscal policy also contributed to the volatile pattern of consumption.  

We therefore have every reason to reduce volatility in the Dutch economy, especially given the economic growth projections for the years ahead. For the years 2020-2025, an average annual growth rate of 1.3% is expected, following average annual GDP increases of 2.3% over the past five years. Whereas an expanding economy improves our well-being, lower growth will act as a drag on the increase in our well-being. However, this can be mitigated if we manage to reduce the volatility of the Dutch economy. This could for instance be achieved by making the pension system more shock-resilient without eliminating the benefits of collective pension savings and risk sharing. Also, the tax benefits of home ownership could be reduced, and the government budget’s stabilising function could be strengthened.