by Don Alexander, MBA
Associate, RSD Solutions Inc.
The push toward austerity as cure-all for rising debt levels resulting from the financial crisis is losing credibility with the euro zone electorate. The elections in Greece and France have served as a shift in the electorate toward a more pro-growth view. Charles Wyplosz discusses these issues in a recent VOXEU communique dated May 2nd.
Wyplosz argues that governments should not mix long-term growth and fiscal discipline objectives with short-term goals to contain rising debt levels. Instead, countries should focus on a framework for fiscal policy cooperation, restructure debts, and implement fiscal discipline in the long-run. The German view, however, is that countries with excessive debt levels should focus on deficit reduction.
This recipe has produced two years of economic contraction and surging unemployment for Greece. There is growing debate among academics and international agencies that advocacy of pro-cyclical austerity is not producing the desired results as the situation is more complicated.
The sovereign debt crisis implies that highly indebted countries cannot simply borrow their way out of the crisis. Financial markets want growth as a necessary condition for deficit reduction, but this is complicated by the fact countries cannot borrow their way out of their predicament nor borrow at reasonable interest rates.
Wyplosz makes five recommendations: (1) do not mix long-term growth with fiscal discipline since they should be treated as independent objectives since there is only evidence that high debt levels can stunt growth, not fiscal discipline; (2) do not create another Lisbon accord that produces another layer of regulations and bureaucrats and serves as a means for politicians to avoid making hard decisions; (3) establish a framework for fiscal policy cooperation at the Eurozone level since recent results implemented by national authorities have been sub-optimal – a fiscal framework may allow for countercyclical policies as needed; (4) authorities should implement debt restructuring ahead of the curve limiting contagion before the market imposes penalty rates and limit market access; and (5) de-emphasize short-term deficit targets which do not have economic justification.
National cooperation on long-term objectives is needed to limit potential risks. However, these types of national agreements need to include short-term flexibility so as to any problems created by short-term market fluctuations. The rigid structure of the infamous Stability and Growth Pact is the exact opposite of what is needed.
As more countries question the role of austerity and attempt to establish long-term fiscal policy cooperation and restructure debt, what kind of surprises can we expect? Risk managers need to focus on this shift to avoid any JP Morgan Chase type of surprises.
For more on this, please follow the link: www.voxeu.org/index.php?q=node/7933
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