Statements from EU officials, European politicians and European policy makers have highlighted growth as an area of concern in addition to debt and the sustainability of high debt levels. Several analysts have argued that fiscal austerity is the wrong way to go for Europe because it will adversely affect economic output. They would rather have European countries facing debt crises not increase taxes or decrease government spending at all. What is being forgotten by the opponents of austerity is that these European countries are at a critical juncture where they have to take decisions that are consistent not only with short-term economic health, but also with short-term and long-term stability, long-term economic output and long-term economic growth. Also being forgotten is the fact that some of these countries have high public debt to GDP ratios at the moment by international developed country standards and some others have high fiscal deficit to GDP ratios by international and developed country standards. And credit rating agencies have been quite unsparing when it comes to rating the treasury bonds of these countries. The concern over increasing treasury bond yields is very real and many of these European countries cannot risk getting into situations of outright debt defaults by allowing debt to GDP ratios to increase to unmanageable levels. Even much larger economies like the United States and Japan are having to take a hard look at their fiscal expenditure items and tax policies. The United States followed an almost perennial low-tax policy in the shape of the elitist Bush tax cuts both before and after the financial crisis of 2008-09 and while a double-dip recession may have been avoided so far according to official statistics, concerns over a return of recessionary dynamics still persist, and the labor market is still marked by high unemployment numbers by historical standards.
One other factor that tends to be ignored amid the hand-wringing about the effect of fiscal austerity on growth, which is based on Keynesian arguments, is that there is a monetary aspect of Keynesianism in addition to the fiscal aspect, and that monetary policy can prove to be efficacious in preventing a structural recession ( by which is meant here the fact that the recessions in several of these countries had their origins in the busts in their real estate sectors after what seems to have been a period of over-investment in these markets ) from spiraling into something worse than what it needs to be. And while one can argue about whether the ECB was prompt enough in providing necessary monetary stimulus, it has provided quite a bit of it in recent days. An expansionary monetary policy and fiscal austerity pull in different directions according to Keynesian logic. However, it may be the one way for these troubled European economies to balance the requirements of satisfying the demands of treasury bond markets and of preventing a real-estate-bust-induced recession from becoming an uncontrollable demand-based spiral. Had the recessions in these countries happened at a time when their debt to GDP ratios and fiscal deficits were less worrying, they could have embarked on both monetary and fiscal expansion. However, since the debt and deficit situations are not as healthy as one would like, the combination of monetary expansion and fiscal austerity seems to be the balancing act that many European economies need to do in order to obtain some Keynesian stimulus without sacrificing the goals of short-term and long-term government solvency.
As for the structural aspect of the recessions, which has to do with labor markets and capital markets readjusting to real estate busts, it will most likely entail a significant amount of distress given the scale of the busts, given the fact that they happened in so many major economies at the same time and given contagion and feedback effects in a globalized economic framework. Is the recent double-dip in economic output in some parts of Europe due to fiscal austerity, is it due to delayed monetary stimulus from the ECB, is it due to an eurozone framework that has inherent limitations with a centralized monetary policy and a decentralized fiscal setup or is it the result of the labor market and the capital market adjusting to the busts ? Perhaps it is a combination of all of these. At least, it is extremely difficult to ascribe it with certainty to fiscal policy alone or to the timing issues in European monetary policy or to a structural readjustment. The recent monetary stimulus may help prevent unnecessary spillover from the real estate sector and that part of the financial sector that was exposed to the real estate market to other sectors. However, the original over-investment and bust in the real estate and construction sectors will also have to work themselves out through the decisions, often imperfect, of numerous economic agents. The history of crises in the real estate sector suggest that these readjustments take a lot of time. And economic science has not advanced to the point where the time-frame for an economy to readjust to a real estate bust can be predicted with any amount of certainty. Each country has its own peculiarities in the way mortgages are structured, the way returns from real estate investment flow to different economic agents, the amount of exposure of financial institutions to the real estate bust, the immediate effect of real estate busts on economic output and government finances, the effect on the treasury bond market and the feedback from the treasury bond market to the financial sector. Some of these dynamics are inevitable in the aftermath of a real estate bust and some others are induced by unnecessary paranoia about investment and demand outlook in the midst of recessions. Stimuli ( whether fiscal or monetary ) can help prevent or offset that part that arises from unnecessary paranoia. However, the part that has to do with labor market and capital market reconfigurations following real estate busts is difficult to address with mere fiscal or monetary measures. At a time when some European economies are undergoing distress due to structural problems arising from real estate busts, ignoring the other structural problem of worsening government solvency situations may just create a situation where stimuli ( monetary or fiscal ) are overwhelmed by the structural aspects. Doing so may mean harming long-term growth in a pursuit of short-term relief. There is a lack of good quantitative analysis as to the amount of spillover one can expect from one sector like the real estate sector to other sectors like the capital goods sector, the automobile sector, the electronics sector, the software sector, different service sectors etc. How much short-term relief can be realistically expected and how much short-term pain is unavoidable due to real estate busts are questions that have not yet been addressed systematically by the analysts. What should emerge from a consideration of the structural aspects and the stimulus aspects, however, is that if one stresses the stimulus aspect so much that one neglects the structural aspects ( like the real estate market, the labor market, the government sector's solvency ), one can end up nullifying the potential positive effects of a stimulus. That seems to be the big question right now in Europe, although the public debate has focused a lot more on the stimulus aspect ( at least in recent days ) than on the structural aspect. A more careful analysis may well reveal that the job of stimuli is stabilization ( prevention of unnecessary recessionary spirals ) first and short-term growth promotion next in the current European context. Also, care must be taken so that excessive emphasis on short-term economic output does not impair the structural aspects so much that the ability of governments to achieve economic welfare goals over the long run is compromised excessively. Or that the ability to sustain long-term growth is not impaired by a narrow focus on short-term economic output. In the middle of serious crises like these, there are no easy choices. Only the most naive would expect that the same kinds of remedies and policy measures that work for milder recessions and milder downturns will work when the crises are more severe, like the current ones. People who want overnight recoveries in Europe would do well to remember that the unemployment situation in the United States has shown only marginal improvement four years after the crisis began in the US and it is likely to take quite a bit of time to return to normal, and this despite the fact that the United States followed generous Keynesian measures, both fiscal and monetary, by extending the deep and elitist Bush tax cuts, by sending out tax rebate checks after the financial crisis began, by bailing out companies, by decreasing interest rates and by increasing the money supply. Structural differences between United States and Europe, as regards the private sector, as regards the labor market, as regards government finances and as regards the kind of welfare systems that the public wants should and have played a role in the differences in policy responses between United States and the European countries to their respective economic crises.
by C. Jayant Praharaj ( send email to cjpraharaj.blog@gmail.com )
The Global Analyst ( Commentary about economic, environmental, political and other topics )
