by Don Alexander, MBA
Associate, RSD Solutions Inc.
French and Greek voters are rejecting austerity, forcing politicians to take the austerity debate seriously. Voters are correct in that it is a bad idea to tighten fiscal policy when growth is so feeble as argued by Charles Wyplosz in recent VOXEU communique (14th May) The impossible hope to an end of austerity. However, the road away from austerity is blocked by conventional policy views that debt reduction has the highest priority – often used to justify risk taking without considering potential implications.
Evidence from Greece and elsewhere is that growth is disappointing and the debt-to-GDP decline is negative and deficits are “surprisingly resistant”. The problem is that most policies take time to work, such as structural reforms that may take several years and do not provide prompt relief.
It is a poor idea to tighten fiscal policy when growth is feeble or negative. The results from budget consolidation are disappointing as the levels of gross public debt remain above earlier estimates and in some countries have increased. European voters do not feel that the economic and personal costs have produced any significant results. The case for fiscal consolidation remains weak when countercyclical action is required.
Monetary policy has some importance as lower rates are needed, but with rates near zero any effect would be largely symbolic. The results from quantitative easing have yet to prove its effectiveness as banks’ focus is on deleveraging. The recent ECB liquidity facility seems largely used by banks to hoard cash rather than make new loans.
Fiscal expansion remain a weak option as a number of countries have lost market access or on the verge of losing it. Financial markets continue to clamor for growth and no austerity, but do not want to provide financing at attractive rates for growth. Even if countries can borrow at attractive rates, can they serve as a locomotive role for growth?
Wyplosz offers several ideas around the policy debate to provide some stimulus: 1) The European Investment Bank (EIB) could borrow and finance spending without adding to the members’ public debt burden; 2) The European Commission could speed up spending on infrastructure to produce some stimulus; 3) Eurobonds could be issued and collectively underwritten by member states; 4) The bonds could be made senior to existing bonds: and 5) The debt of some countries could be restructured. The author concludes that all the policies combined would not be enough of a stimulus.
The problem is holding governments to infeasible debt reductions for a couple of years that will take decades to resolve. Otherwise, voters will continue the protest and the austerity debate will remain a “hot” political issue. As in risk management, conventional wisdom does not always provide the best answer.
For more on this follow the link: www.voxeu.org/index.php?q=node/7988
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