It is essential that European governments support the economy during a phase of private-sector deleveraging to avoid what would otherwise lead to a deep depression.
Wolfgang Münchau, Financial Times
The popularity of austerity with Europe’s policymakers is plain for all to see. However, the merits of such an approach are far more questionable. Efforts to cap national budget deficits in the region have been described by Wolfgang Münchau — and apparently those he speaks to — as ‘quite mad’. Such measures as ‘pro-cyclical’ — they force governments to cut spending (or raise taxes) during downturns. This is self-defeating: if governments withdraw, then at least the short-term effect will generally be to exacerbate recession.
Greece is a contemporary example of this effect. Indeed, with every step the Greek government takes to balance its books, it finds the target moving further away — despite harsh cuts in spending, Greece has consistently failed to meet its deficit targets. And yet countries in debt-induced turmoil follow the same prescription.
Now the new Spanish government, led by Mariano Rajoy, is headed down the same path. It has committed to deficit targets of 4.4 per cent in 2012 and 3 per cent in 2013. But Rajoy is committing to public sector debt reduction at the same time as Spain’s private sector is deleveraging on a massive scale. That process has been ongoing since 2007, and has been largely offset by the government’s balance sheet swelling. Münchau regards that as warranted and sensible. By cutting debt now, the Spanish government threatens to deepen the recession the country is already facing. Such prolonged pain, in Münchau’s estimation, is a far greater threat to the Eurozone than concerns about high debt levels.
