Will the end of austerity break up the Eurozone?

With the elections in France and Greece Sunday, both supercharged by debt, deficits, and economic desperation, Europe is about to take a dramatic new direction.

By The Fiscal Times May 7, 2012 11:40AM
By Patrick SmithThe Fiscal Times

With the elections in France and Greece Sunday, both supercharged by debt, deficits, and economic desperation, Europe is about to take a dramatic new direction.

The eurozone is turning away from stringent austerity policies and toward those that stimulate demand. President-elect Francois Hollande, the first socialist president since Mitterrand, plans to raise taxes on the rich to meet some of his growth objectives.  However, without a credible debt reduction plan, Hollande risks a loss of confidence among investors and bondholders. 
The U.S. got certain things right these past years of recession, which is why we are in better shape than Europe now. And we got certain things wrong, which is why our recovery seems to have a serious vitamin deficiency.

In the “right” column, Americans did not go after federal deficits and budget overruns with no thought of the demand side of the economy. This included a large stimulus package and bailouts for American financial institutions with their backs to the wall.

The Europeans missed the stimulus component of policy; what they are now about to do is compensate for the error. In America’s “wrong” column, there is only one item: The stimulus measures put in place early in the Obama presidency were not sufficient, and economists who said so at the time should get more credit. This is precisely why the jobs numbers came out at the end of last week were disappointing.

Until now Europe has lived by a Continent-wide economic policy fashioned by Germany, supported by France, the Netherlands, and other north European nations,  and featuring austerity and structural reform as prescriptions for countries struggling with high sovereign debt, burst housing bubbles and wobbly banks, weak economies, and rising unemployment. Just for the record, unemployment across the European Union reached 10.9 percent last week—its highest since the euro was introduced in 1999. That is typical: It has been clear for ages that the policy mix in Europe was wrong, but no one would say the emperor had no clothes.

That is what is now changing. Ever since Hollande won the first round of polling three Sundays ago, senior officials across Europe have been lunging for the microphones to announce their belief in policies that offset austerity with demand-focused stimulus.

Late last week, Mario Draghi, president of the European Central Bank, asked Brussels to produce a 10-year plan for the euro with growth policies as its centerpiece. Part of what Draghi wants in the decade-long vision he proposes is what has been at issue since the Greek crisis nearly tipped over the E.U.’s common currency last autumn: more political integration so that economic and fiscal policies can be better managed throughout the E.U.

The next day Olli Rehn, the E.U.’s vice-president for economic affairs, echoed many of Draghi’s thoughts and added some of his own. The fiscal pact established last December can be applied flexibly, for instance. Spain, as a ready example among the desperadoes, can move its target for its deficit—it is now scheduled to drop to 3 percent of G.D.P. by next year—out a year to 2014. “The pact entails considerable scope for adjustment when it comes to application,” Rehn said in Brussels.

What will Europe do now, then? I am looking for a new, improved version of the American strategy. It is already clear that Hollande, the Socialist victor in France, will fundamentally change the European conversation. We just do not know how, and we will not know until Hollande gets on a plane for Berlin to meet German Chancellor Angela Merkel.

The hard-edged policies Europe has had in place for the past several years—and which have now brought it close to depression—are Merkel’s baby. In the best of outcomes, Merkel’s discipline and reform can be combined with Hollande’s stimulus and flexibility to produce a healthy European policy that stretches out sovereign debt, improves demand in strong economies such as Germany’s, and thus induces growth in the ailing peripheral nations.

This does not mean a return to fiscal slovenliness. Neither does anyone expect a rethought policy in the E.U. to excuse the Greeks and others from existing commitments. Quite the opposite. The major international agencies—the International Monetary Fund, the E.C.B., and the E.U.—are all prepared to provide further funds; Christine Lagarde of the I.M.F. made this clear last week, and now Draghi and Rehn have spoken. But this will be on a disciplined basis.

The fundamental question is, Where does growth come from? Europe is concluding that it lost its bet on austerity alone and now expects a mix of policies --  including stimulus to provide the growth needed to bring down debt levels and pay private creditors (even if terms are stretched out) – to get economies moving, and get Europeans back to work. Investment in public-sector projects is a time-honored place to begin.

Hollande’s big ideas so far include allowing the issue of common European bonds to finance large infrastructure projects (as opposed to financing debt repayment). He wants Draghi and the E.C.B. to ease interest rates. Last week Draghi disappointed many when he held the bank’s basic rate at 1 percent; under the circumstances, it ought to be lower. Hollande also proposes a tax on financial transactions, doubling the E.U.’s rescue facility to $1.3 trillion, and letting the fund borrow from the E.C.B. At home, Hollande wants to spend $28 billion on job-creating public investment this year and more than that in 2013.

This is the thinking of a moderate Socialist, and one hopes that markets do not swoon as if Marx himself had just been elected. Equally, the rating agencies will be highly misguided if they downgrade nations such as Spain, Italy, and Greece without giving a fundamentally new policy time to work.

The line from Berlin is that Merkel can accept much of Hollande’s program -- a good sign for the markets -- but will draw the line at any policy that causes European inflation to rise. Some analysts, such as Gideon Rachman at the Financial Times, think this cannot be done. His position is TINA, as the English nicknamed Margaret Thatcher: ‘There is no alternative’ to austerity. I disagree. Take inflation, for example: How great is the danger of inflation when you have a Continent-wide jobless rate of 11 percent—and in some countries rates of more than double that? Virtually nil. Inflation is not the perilous zone it can sometimes be.

In this sense, timing counts. A set of policies that may work under certain economic conditions may work calamitously under others. That is the lesson I draw from the elections in Europe. Sarkozy is the 11th European leader to lose his job over the direction Europe has taken. Depending on how coalition talks go in Athens, Prime Minister Lucas Papademos would make a dozen. In the best of outcomes, Americans will derive a lesson or two from Europe before drawing the curtain and pulling the voting lever next November.

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Patrick Smith is a columnist at The Fiscal Times. Subscribe to The Fiscal Times' free newsletter.

May 7, 2012 5:08PM
Socialism is the end of a civilization, not its beginning. The nanny state has only one end, Bankruptcy!! There are two ideas people should not worry about. Gays and government debt. They both solve themselves naturally. Gays by natural selection, and socialism by bankruptcy!!
May 7, 2012 8:06PM
This article is another liberal news media article trying to OK socialism.
May 9, 2012 12:15PM

The right and wrong column are both wrong. The stimulas did little to right the ship. Money was given to banks that should have been permitted to fail, they deserved it because of their incompetance & greed. Our ecomony is still limping along becuse of endless Government inteference in business. EPA regulations gutting the coal industry,

federal Government refusal to grant oil drilling permits on public land and Keystone pipline road blocks are all job killing examples that this administration has persued. Why hasn't the administration lowered corporate taxes so companies better compete globally? Why hasn't the administration persued Natural gas technology utilization?

Because they are incompetant!!!!!


May 9, 2012 12:56PM
The dulcet tones of Jim Grant provided much food for thought on Tom Keene's Bloomberg Radio show this morning. While the interest rate observer did not change his tack on the extreme experimentation of world's central banks, he did have some new perspective on the incredible moral hazard (or unintended consequence) that is being created. One of his main criticisms is the incredible arrogance and conceit of a central banking system that believes it can see the future and thwart things before they come to pass, as he notes "I blame the central bankers for confusing the black art of central planning with the traditional art of central banking". He fully expects more easing by the Fed and its friends as he awaits their response to this latest stumble in the markets but what is most evident to him is that "The Fed owns the stock market" since they have financially repressed all investors into risky assets they now have been forced to have a moral responsibility to keep us safe in those assets - incredibly! The Fed is more likely than not to intervene with still more money-printing in any effort to keep this bubble afloat. What Jim focuses on is the morality in economics and the current immoral policies that have very bad consequences.
May 11, 2012 2:34PM

Like more of the same (government spending programs running up debt) is going to fix the debt problem. The economist who invented this idea did not live in a world where governments were already so heavily indebted, so his thesis seemed to work. But where governments owe more than their GDP it is not going to work, it's going to pull them down the black hole.


And like the so-called stimulus worked so well in the US. We spent most of that taxpayers' money (and extra debt) for these things:

1. Rewarding people for going into deeper debt (with house and car purchase credits), so the next financial shock will put them in the welfare rolls.

2. Undoing the welfare reform of the 1990s, re-incentivising the States to increase their welfare rolls and dis-incentivising people from seeking employment.

3. Lengthening the unemployment pay. Since most people take a job right before unemployment pay runs out, basically just increasing the unemployment rolls.


Does this sound like a program to make an economy healthy? Sounds more like a program to increase the Democratic party's membership.



May 10, 2012 10:32AM
Dude put the crackpipe down and step away from the computer.  You dont have the brain capacity to write articles.  We needed more stimulus?  Are you crazy or did someone beat you with a stupid stick.  Let the banks that took big gambles fail.  Why give them more taxpayer money.  Socialism will be the end of our great country as we know it.
May 11, 2012 2:42PM

The so-called "common European bonds" are just a transparent way to make Germans responsible for the debts of other countries, and every German taxpayer knows this. This has about as much chance of getting approved as a pig winning the Kentucky Derby. If it somehow were, Germany would leave the Euro currency, and let them inflate it out of existence without them. If they didn't leave, they'd derserve what they get I suppose.

May 8, 2012 4:56PM
Too little, too late.  Look at the US.  Smile
May 7, 2012 4:32PM
Hope you are watching Paul Ryan. Try your austerity crap here and, we the people will do the same!!!
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