Rates triage for a feeble Europe

The unemployment rate in the eurozone reached a new record high of 11.8 per cent in December. This is yet another signal that the labour market in the world's largest economic region needs a decent bout of economic growth to stabilise. Any improvement, which means a steady and sustained fall in the unemployment rate, needs economic growth to be robust for several years.

From so many perspectives, this is dismal news on the labour market and it comes a week after Olivier Blanchard, the International Monetary Fund's economic counsellor and Daniel Leigh, its chief research economist, published a paper that concluded that fiscal consolidation and other policy austerity is unbalanced, over zealous and has had a much more constricting effect on economic growth than anticipated.

In other words, fiscal consolidation is an unexpectedly large contributor to the woeful unemployment picture in Europe.

That constricting influence from severe fiscal austerity in the countries that "need it" most as they try to satisfy their creditors, has smashed their domestic economies and workforces. The unemployment rate in Spain is 26.6 per cent, in Greece 26.0 per cent; Portugal 16.3 per cent; Ireland 14.6 per cent and Cyprus 14.0 per cent. Yet these are the countries that have been compelled to slash spending, cut wages and entitlements, defer capital expenditure and impose all measure of austerity for the sake of meeting arbitrary budget targets set by the European Commission, IMF and European Central Bank, the so-called troika of bodies that determine how bailout money is distributed.

To be sure, the fiscal position of these countries was not sustainable. Years of poor economic policy management, a slack application of tax laws and ridiculously generous entitlement spending have delivered a legacy of chronic government debt and has completely eroded investor confidence in those countries. But as Blanchard and Leigh note when examining the data for 27 countries back to the 1930s, "We find that forecasters significantly underestimated the increase in unemployment and the decline in private consumption and investment associated with fiscal consolidation.”

This means that the so-called multiplier effect of government decisions to cut spending, cut entitlements and increase taxes is far greater that just the value of those measures. Blanchard and Leigh noted, "that short-term fiscal multipliers have been larger than expected” during the current crisis.

This brings into question the economic policy strategy in much of the eurozone and the UK which still has a significant fiscal contraction working through their economies over the next few years. That withdrawal of economic activity being delivered by the government sector needs be more than offset by a surge in private sector activity if there is to be decent economic growth. That is not happening at the moment. "Decent” growth in the eurozone would be several years of 2 per cent plus GDP growth, a level that is light years away from the consensus forecasts for 2013 and 2014.

But there in lies the problem for the eurozone.

The current record high unemployment rate is likely to rise further and GDP growth is being undermined by swinging cuts in government activity; but those cuts are essential if the likes of Spain, Greece and even Italy and Portugal are to qualify for the ECB's bond buying program or to receive access to the bail out funds so that they don't default on the debt obligations.

Something has to give otherwise these dreadful unemployment numbers, including youth unemployment at 23.7 per cent for the region as a whole and 57.6 per cent in Greece and 56.5 per cent in Spain, will stay dreadful for many years.

That poor labour market news was countered, to a small extent, in other eurozone data overnight. There are a couple of tentative signs that better economic conditions are slowly unfolding. The European Commission's economic sentiment index rose for a second month to 87.0 points in December from 85.7 in November. Retail sales in the eurozone registered a rare increase in November, albeit a gain of 0.1 per cent. It was the first rise in retail spending in four months and needs to pick up substantially more if there are to be any inroads into the unemployment rate, but at least it is encouraging to see sentiment and retail spending off the floor.

The ECB meets later this week and even though there is scope for it to cut interest rates from the current 0.75 per cent level, the market consensus is that it will again postpone the decision to reduce the rate to 0.5 or even 0.25 per cent. While a rate cut would not be a solution to all of the ills of the eurozone especially with the ECB undertaken to buy bonds, it would seem an easy and low cost option to cut rates to either instil a little confidence, reduce the value of the euro or indeed, encourage much needed private sector borrowing and investing.

The 18.8 million unemployed people in the eurozone would no doubt be pleased to see the ECB do something extra to try to kick-start the economy and a rate cut would seem a proverbial no-brainer.