A fearsome fiscal missive from Europe

It was a grim session for euro-watchers with a raft of disappointing news.

While the optimists on the eurozone economy would have been buoyed for a moment by the stronger than expected rise in German retail sales in September, the reality of a record high unemployment rate and the debacle of the Greek budget highlight the massive problems still confronting policy makers. At the same time, inflation in the eurozone remains low, which is not surprising given the ongoing domestic recession and global disinflation flowing from the weakness in commodity prices.

The low-light for the eurozone was the jump in the unemployment rate to a record high of 11.6 per cent or 18.5 million people. Within the eurozone, Spain has the highest unemployment rate at a mind-numbing 25.8 per cent while Austria has an unemployment rate of just 4.4 per cent. There is a growing consensus from market economists that the unemployment rate will reach 12 per cent early in 2013 despite the recent efforts from the European Central Bank to boost the economy with extremely easy monetary policy.

The failure of the eurozone to grow and the persistent economic gloom is being driven by fiscal austerity as most member countries work to lower budget deficits and in time, cut government debt. While the ECB is trying to pump up economic conditions, governments are cutting wages, services and hiking taxes.

This trade-off makes Professor Joe Stiglitz from Columbia University "very pessimistic” about the prospects of a recovery in the eurozone. Speaking on Bloomberg television overnight, Professor Stiglitz said, "basically Europe has put in place austerity packages that almost inevitably will lead the economy to become weaker, they haven't put in place anything that will promote economic growth.” He added, "it's difficult to see what the impetus for real growth in Europe will be.”

And he has a valid point. While ever the government sector is slashing spending and lifting taxes, a recovery will be hard to achieve. It is worth recalling that government demand accounts for around one-quarter to one-third of aggregate demand in most eurozone countries.

In terms of austerity measures, the Greek government handed down a fiscal update which on any measure is frighteningly dismal. The hard facts on the Greek economy point to a situation that must be rivalling some of the worse economic catastrophes in modern history.

Already, GDP has fallen a cumulative 21.5 per cent from the 2007 peak and the updated forecast is for a further 4.5 per cent drop in GDP in 2013. The net government debt to GDP figure was revised up by more than 10 per cent of GDP to 189 per cent, a level that would see total government revenue from all sources fall short of covering interest funding costs were it not for the assistance of the ECB, the IMF and the European Commission (the troika). The unemployment rate is 25.1 per cent, with youth unemployment at 55.6 per cent and while the depressionary economic conditions persist, there is little hope of it turning lower.

Yet the austerity measures continue. The troika is meeting later in November to consider the "progress” Greece has made in meeting the conditions set for it to qualify for further financial assistance. Unless the troika approves the fiscal package, Greece will effectively run out of money on 16 November, with the maturity of some short-term funding that will need to be refinanced.

The pressure is building. Greek Prime Minister Antonis Samaras said, in the frankest of terms, "if the deal does not pass, the country will be led to chaos”. The budget update from the government confirmed a lift in the retirement age to 67, further cuts to salaries and pensions, an increase in the tax rate on interest earned on bank deposits and more cuts to healthcare.

These seem a bare minimum for the troika to approve additional bailout funds.

It seems almost trite to mention the data on eurozone inflation in the wake of that news, but confirmation that annual headline inflation eased to 2.5 per cent in September, with annual core inflation dropping to 1.5 per cent, has reinforced expectations that the ECB will cut interest rates from 0.75 per cent to 0.5 per cent at its next meeting. It has little to lose and it might just help a bit.

There were grounds for some optimism or hope when, two months ago, ECB President Mario Draghi indicated that he would do "whatever it takes to hold the eurozone together” and in doing so, announced an open-ended program to buy the bonds of member governments in need of assistance. That optimism may well be fading as the harsh economic reality highlights the extent of the problems that will take more than easy money from the ECB to fix.