Sovereign Debt and the Euro-zone.

In the Spring of 2010, governments around Europe began announcing and preparing fiscal austerity measures to address budget and structural deficits. These plans for austerity measures owe their prompt formulation to the Greek debt crisis, and the threat it presented to the stability and viability of the Eurozone as an economic union. Greece itself announced austerity measures as a condition to receive a ‘bailout’ y the European Union and the IMF. The funds provided by the EU came primarily from France and Germany. However, as market and media attention underscored, and perhaps even created a ‘debt-phobia’ that has spread across Europe. As a result, Britain and even France and Germany have had to announce austerity measures to address fiscal deficits in order to calm markets and avoid greater concerns about their deficit levels. Even Hungary, a country that is not part of the Euro currency zone, has had to announce similar austerity measures, despite retaining monetary policy as recourse to address their economic situation.
Upon analysis, it stands out that Britain, France, Hungary and Germany have significantly different economic circumstances than Greece. However, they are bond markets and political pressure expects them to implement similar fiscal and economic measures. It is important to remember that a similar process contributed to the advent of the Greek debt crisis. The Euro countries, upon adopting a common currency, depended upon the implementation of similar fiscal, economic and political measures to maintain stability within the Eurozone. Greece did not do so, and the crisis emerged.
The most troubling consequence of the implementation of austerity measures across the board in Europe, and throughout most countries in the global economy is that such measures could hinder the strengthening of aggregate demand and halt the economic growth necessary to recover from the economic contractions of 2008, 2009 and in some cases, the first quarter of 2010. Much of this slow growth can be traced back to a figure that has been ignored since Europe’s debt woes took front page news: unemployment. Basic macroeconomics teaches us that the most significant force behind GDP measured economic growth is, at least in the immediate term, consumption. In the United States, unemployment still hovers around 9%, from a high of around 10%. Out of 8 million jobs lost since 2008, only 500,000 have been recovered so far. Un the UK, as of January-March 2010, the unemployment rate is actually the highest since the same period in 2008. Hungary faces the same situation, with unemployment at 11.8%. For the Euro currency area, it stands at around 10%. All this unemployment quite simply means consumption power and potential lost. As a consequence, a much smaller consumption figure will be factored in GDP. Simple math tells us the when adding a lower number, the result will come out to be less than when adding in a higher number.
Those who argue for fiscal austerity claim that, at present, extra injections of money into the economy would create inflationary pressure, sovereign debt defaults, or both. They would normally be right had it not been for the recession the global economy (or most of it) is still trying to recover from. Upon the present circumstances, the true danger lies in deflation, not inflation.
Recent economic developments have demonstrated that if a recovery is not on its way, it is already taking effect. Sectors of the economy other than unemployment have shown signs of recovering. This recovery, however, remains fragile. It is not time yet to pull the plug on the cash influxes is the US, UK and Europe. Growth is still not strong enough to be sustained by its own. If there is one country that can start talking about an ‘exit strategy’ in terms of raising interest rates and cutting back on stimulus spending, it is Brazil, who has GDP growth figures this year of around 10%. In the US, UK and Europe, growth is closest to 1%. If the cash flow is halted in these economies, two things can happen. The first is a double dip recession, where the growth created by stimulus injections and low interest rates disappears. The second is deflation. The minimal growth experienced in the Western economies would not be able to be supported due to high levels of unemployment. Prices would drop, and sovereign and government deficits would soar in real value. This realization should give ‘fiscal hawks’ something to worry about.
If Western economies really want to recover, they must understand another basic economic principle: investment. Fiscal hawks argue that we cannot afford to keep spending ‘money we don’t have’ and that we should learn ‘lessons from Greece’. All that is true. However, governments must understand that the moment to stimulate economic growth is now, as opposed to never. With interest rates as low as they are, governments are in a better position to do this; despite bond market worries about debt. If on the contrary, governments decide to cut back on expenditures,, they run the risk of suffocating future economic growth. After that happens, when governments inevitably find the need to borrow again, interest rates will be higher, and the next recovery will be more costly than the last one. That is a considerable cost to consider. The guiding principle behind economic policy today must be to spend a bit more now in order to save much more later on.
This episode of ‘debt-phobia’ should lead to a reflection about the information that guides economic policy making these days. Frankly, much of this ‘debt-phobia’ owes itself to sovereign bond market reactions, which are then translated into political pressure under the guise of economic expertise. Are crediting agencies to be trusted to enact economic policy? In Greece, crediting agencies downgraded Greek sovereign debt upon the emergence of the debt crisis. Upon the passage of austerity measures required to receive IMF/EU funds, how did crediting agencies react to the measures that were designed, in part, to calm them? They downgraded Greece’s debt further, citing concerns that the austerity measures would inhibit economic growth, and therefore also inhibiting the ability of Greece’s government to collect higher amounts of tax income necessary to pay off their loan.
This episode relays the importance of governments having power over their economic decisions, which includes monetary policy in most cases. At present, too many determinations of economic policy are based upon external agents, such as crediting agencies, and foreign countries with different economic contexts. Such an example can be found in Germany’s push for the European Central Bank to raise interest rates. Germany, and its economic policies are known for their excessive, but founded fears of inflation, which date back to the days of the Weimar Republic. At present, Germany’s push to raise ECB interest rates risks choking off economic growth, and appreciating the Euro, leaving Germany and the rest of the Eurozone countries vulnerable in export competition. Considering it is the largest exporting economy in Europe, Germany clearly has the wrong focus. Its push to cut deficits rather than fostering growth will have serious consequences for Germany, but also for many other European countries, who do not have the economic and political leverage Germany does. Now they are subject to Germany’s economic determinations. All of this because of ‘debt-phobia’
Fiscal hawks claim that behind their calls for fiscal austerity lies common sense. That if a country keeps spending money while incurring in losses, it will go bankrupt, like any other company. That governments should ‘tighten their belts’ in tough economic times, like any other family. That what happened to Greece will happen to everyone if governments keep running deficits. It is time for them to learn the differences. As Paul Krugman said: “a country is not a company”, and much less a household. That there are significant differences between the economic conditions and figures of Greece, and the economies of the US UK, and most of Europe, and that all things are not equal when it comes to a global economy. And that economics is not accounting.

-Abraham Mercado ’12

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