Budget cut fever sweeps Europe
What’s at stake: Fearful of becoming the next Greece, European governments are lining up to demonstrate to investors that an era of austerity has begun. The severity of the steps being enacted varies by country, as does the timing, but most of the measures centre on freezing or cutting public-sector pay, increasing retirement ages and reversing temporary tax breaks and other cushions that were encouraged in 2008 and 2009 to help beat back the worst recession in decades.
Francesco Daveri writes in LaVoce that we are witnessing an unprecedented political and social experiment as, for the first time, Europe as a whole is reducing public expenditure. Even countries not deemed at risk of default or the need to accelerate their exit strategy, are launching their cuts. Mansoor Mohi-uddin sums up the policy dilemma facing Europe: If growth remains weak and governments decide to cut their budget deficits quickly, then investors may react negatively if that leads to recession again. On the other hand, if governments are thought to have lost control of fiscal policy and are unable to pay back their debts then investors will also react adversely.
Eurointelligence notes that the European media have a very different interpretation of the economic effects of austerity. Unsurprisingly, the Germans believe that austerity is the answer to everything as illustrated in this Der Spiegel article. Les Echos, on the other hand, wonders whether the austerity plans will compromise the growth perspective for the region.
Paul de Grauwe argues that financial markets are forcing too much austerity. One after the other the Eurozone governments are forced by the fallible judgment of the financial markets and the rating agencies to exit the budgetary strategies set in place to save the private sector. By forcing austerity now, financial markets make recovery more difficult thereby also making it harder to correct government deficits and debts. A self-defeating deflationary dynamics threatens to envelop the whole Eurozone. For that process to be stopped, the governments of the Eurozone have to set aside the belief forced upon them by the financial markets that the cause of the present government debt crisis is to be found in the past budgetary profligacy of the same governments. It is not. The source of the government debt crisis is the past profligacy of large segments of the private sector, and in particular of the financial sector.
The WSJ blog writes that Hooverite policies haven’t arrived in all of Europe yet. A note by J.P. Morgan Chase economists argues that the news this week out of Germany, France and Italy largely reflects decisions about how the fiscal tightening that has already been planned for next year will be achieved. And a note by Goldman Sachs economists which overviews the new fiscal measures and their likely impact on Europe’s growth argues that the additional tightening measures that have been announced since the mega-European rescue package was launched will only restrain GDP growth by 0.1%-0.6% at moment of peak impact. They furthermore expect this impact to be broadly neutralized by the recent depreciation of the trade-weighted euro.
Alberto Alesina, Dorian Carloni and Giampaolo Lecce present evidence that fiscal adjustments do not increase the likelihood of electoral defeat for incumbent governments. The bottom line of their paper is that it is possible for fiscally responsible governments to engage in large fiscal adjustments and survive politically. Moreover, acting on the spending side is no more costly that doing on the tax side. A sense of urgency because of impending crisis, a bit of time between the adjustment and the next election, good communication with the public, are ingredients that help. Fiscal problems in Europe can be solved. Large adjustments based on the spending side work as shown in Gros and Alcidi, they are not recessionary and are not the kiss of death for the governments implementing them.
Econospeak notes that the consensus that the deficits have to be cut as quickly as possible do not stem only from Europe. This is also the message sent from the Group of 30, the latest OECD economic outlook, the Obama’s deficit commission and the US Congress. If so many governments simultaneously decide to withdraw stimulus, the combined effect could well be to tip the world into a second round of economic tailspin. Martin Wolf and Paul Krugman are especially critical towards the OECD: Krugman says their latest publication amounts to conventional madness.
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