Created as a crisis tool by the EU Competitiveness Observatory, the Macroeconomic Imbalance Procedure appears relevant in the current context of rising inflation. This year, it is directly integrated in the annual Observatory letter published on 21 September. It shows Luxembourg’s performance, assessed according to a scoreboard of external, internal and employment-related imbalances. The data were extracted up to mid-July, i.e., 

Last year, on the basis of this analysis and in the midst of the covid pandemic, the European Commission concluded that Luxembourg did not have any clear macroeconomic imbalances, although there were risks linked to rising house prices and household debt. These risks have increased again in 2022, and this year youth unemployment, which has been growing steadily for the last three years, is also a cause for concern.

Despite this, the commission’s conclusions remain positive as it states that “there are no proven macroeconomic imbalances in Luxembourg”. This conclusion should not, however, hide the fact that with the deteriorating global economic situation, Luxembourg is this year on the verge of certain imbalance thresholds, which have sometimes been exceeded in certain areas, even if this does not call into question the economy's overall equilibrium.

No overall imbalance, but a mixed performance

The external imbalances component does not indicate any risk. On the contrary, all the indicators for this component are in the clear for Luxembourg. As of the 15 July cut-off date, the current account balance remains stable at 4.5% of GDP over three years (threshold at 6%), public debt is down to 24.4% of GDP (the threshold is 60%) and its foreign asset liabilities are down to -3.6% (threshold of 16.5%). In line with a current account surplus, Luxembourg thus respects the criteria set for the net international investment position balance, its foreign assets being (largely) higher than its foreign liabilities. The budgetary measures that were taken during the tripartite to fight against energy inflation . Certain aspects could then be on the verge of critical imbalance thresholds, notably the nominal unit wage cost, currently at 7.8% (the threshold is 9%) with the announced indexations.

Moreover, half of the indicators in the internal imbalances component are already significantly above their respective thresholds, namely the house price index, private credit flow, private debt, and the youth unemployment rate.

Private debt and house prices in the spotlight

The house price index is at 11.2%, whereas the imbalance threshold is 6%, i.e., well above. The private debt of non-financial companies, private households and non-profit institutions is at 316.8% (above the threshold of 133%), up, as is private credit flow, at 44.1% (compared to the threshold of 14%).

According to the European Commission, “a high level of credit flows seems to be one of the best indicators for predicting the incidence of crises at an early stage”. The current energy crisis is having a huge impact on SMEs and households; these figures can be expected to increase further in 2023, despite the government’s measures. Large credit fluctuations are very often associated with boom and bust cycles in asset markets, potential vulnerabilities in the banking system, real estate bubbles and current account imbalances. More debt and more credit for households combined with continuously rising house prices pose a high risk of social imbalance.

According to the observatory, between 2015 and 2020, the house price index has risen by more than 40%, while the adjusted median net disposable income has only risen by 7% over the same period. The commission seems to be taking this seriously as it states that this recent development marks “a risk of overvaluation of assets which, in addition to potentially increasing the risk to the country’s financial stability, deteriorates the ability of the median household to acquire a property, as income growth and debt cannot keep pace with the dynamism of house prices”.

Good employment trends, except for young people

On the employment front, the three-year change in the activity rate of residents was up slightly, by 2.1 percentage points (comparing the active population) since 2019 and is thus well within the threshold (less than -0.2pp) defined by the MIP.

However, Luxembourg shows a variation in the youth unemployment rate fluctuating around the threshold limit (2 pp). Estimated at 2.7pp in 2022, the critical threshold is exceeded, as in 2020, when it was 2.8 pp. The observatory’s assessment nevertheless points out that the figures on youth unemployment should be taken with a certain amount of caution, as the methodology used for the count does not necessarily distinguish between partially active young people, students included in the non-active category and active young people who are actually unemployed.

This story was first published in French on . It has been translated and edited for Delano.