We have reached a point where the policies adopted to resolve the eurozone debt crisis are causing more damage than whatever may have caused the problems in the first place. This is painfully obvious inGreeceand increasingly so inSpain.
The troika of theInternational Monetary Fund,European CommissionandEuropean Central Bankis now demanding thatGreecefront-load austerity measures for 2013 on the grounds that the country is certain to miss the nominal deficit target for 2013. The Greek government had forecast a fall in gross domestic product of "only” 3.8 per cent, but the troika believes the fall in GDP is more likely to be of the order of 5 per cent, according to the Greek newspaperKathimerini. That would imply thatGreecewill miss the overall goal of a primary surplus (the surplus before the payment of interest on debt) next year.
Why is Greek GDP falling so fast contrary to what official forecasts have claimed? The global economic outlook might not help. But the Greek economy’s year-in, year-out annual shrinkage of a magnitude of 5 per cent is caused primarily by the relentless pursuit of nominal deficit targets. If the economy misses the targets, more austerity is applied, which causes a continued fall in GDP, followed by another failure to meet the target. In other words, the troika is demanding policy action whose effect will be a further deterioration in the Greek economy, and thus a further deterioration in the debt ratio, which in turn requires further policy action of the same self-defeating kind.
Spainis not quite there yet but it is heading in the same direction. Luis Mara Linde, governor of theBank of Spain, last week told the budget committee of theCongressof Deputies thatSpainrisks missing this year’s deficit target. He recommended that the government adopt further austerity measures to make up for this shortfall. Since nobody, including presumablyMr Linde, believes in the Spanish government’s optimistic prediction of a 0.5 per cent fall in GDP next year, the probability of a large shortfall in the 2013 deficit is close to 100 per cent. As in the case ofGreece, there is a dynamic at work inSpainwhere policy makers are chasing a nominal target, piling on one austerity programme over another, and then missing it by a wide margin.
As a member of the troika inGreece, the IMF is part of this self-defeating approach. One wonders sometimes whether this is the same IMF that in its latest World Economic Outlook produced a very thoughtful analysis of past debt crises*. It came to the conclusion that deficit reduction programmes can function only under certain auspicious conditions and must not be pursued in a blind, mechanistic sort of way. "The first lesson is that fiscal consolidation efforts need to be complemented by measures that support growth: structural issues need to be addressed and monetary conditions need to be as supportive as possible,” it says.
So what kind of structural and monetary conditions need to be in place? Successive Spanish governments have announced many structural reforms, mostly irrelevant to the crisis. The reform that would matter the most -- the closure of the unprofitable savings banks and the consolidation of the entire sector -- is not happening for political reasons. I recoil when I hear Luis de Guindos, Spain’s finance minister, saying that he does not expect a single Spanish bank to close down -- despite the fact that, taken as a whole, the Spanish banking sector is insolvent.
When the IMF talks about supportive monetary policies, one might at first conclude that this condition is more or less fulfilled. The ECB’s official short-term interest rate is low. It supports the banking sector with unlimited liquidity. It may soon support the Spanish state through sovereign debt purchases. But monetary conditions are far from loose inSpain. Real interest rates, both for the Spanish private and for the public sector, are depression-inducing.
Spainthus does not fulfil either of the two conditions stipulated by the IMF as a successful prerequisite for debt reduction. In the absence of a very big change in policy, we should expectSpainto go down the same tube as Greece.
European policy makers have always clung to the hope that a subsequent recovery would take care of all the problems. They chronically underestimated the effect of austerity on growth, especially if other countries in the region pursue the same policies. As the IMF noted in its study, many successful episodes of debt reduction were accompanied by good economic growth elsewhere.GreeceandSpainare not so lucky.
My conclusion is that present policy is not consistent with these two countries’ survival in the eurozone. This is not a prediction that they have no choice but to leave. It is merely a statement of policy choices.
*World Economic Outlook,October 2012, ch.3, "The good, the bad, and the ugly: 100 years of dealing with public debt overhangs”
Copyright The Financial Times Limited 2012.