Dr Andrew Lilico, June 2013Is Austerity Enough to Save the euro?
1. Austerity alone won’t be enough to save the euro2. Debt pooling (e.g. Draghi) is making things worse3. Don’t expect ECB to inflate as much as Fed or BoE4. Expect to see increased use of gold & bank bail-ins5. Political way forward is to Single European State2Key Messages:
There are major austerity programmesacross much of the €urozone3Program tax revenuesas % of GDP publicexpenditure as %of GDP fiscal balance as % ofGDP expenditures from peak totrough as % of totalexpenditure in peak yearAusterityplansPortugal 1% -7% 7% -13%Ireland 1% -6% 7% -6%Italy 1% -3% 4% -1%Greece 1% -12% 13% -24%Spain 2% -5% 7% -6%Belgium 1% -2% 3% No fallFrance 2% -4% 6% No fallAustria -1% -3% 2% No fallMemo UK 2010s 1% -8% 9% -6%
In a currency union, austerity is aboutcontrolling government deficits & debt…42010 figures (Eurostat) Govt debt to GDP Govt deficit Bank assets toGDPAvg Growth 2000-2010“Unsalvageable”Greece 143% 11% 173% 2.4%Cyprus 61% 5% 586% 2.8%“Banking crisis”Belgium 97% 4% 182% 1.4%Spain 60% 9% 335% 2.1%Ireland 96% 32% 328% 2.4%“Competitiveness Crisis”Italy 119% 5% 163% 0.2%Portugal 93% 9% 240% 0.7%
…but austerity is also about restoringcompetitiveness5Source: Europe Economics & Open Europe
It’s simply not true that more deficit alwaysequals more stimulus6Does a 99% of GDPdeficit provide morestimulus than a 98%of GDP deficit?At some point “Non-Keynesian” effectsmust dominate:• Signalling effects concerning thegrowth rate of the economy High spending = low growth• other wealth effects on consumption Deficits resolved / debts paidwith taxes• credibility effects on interest rates “Gilts strike” / “yields spike”
Often Fiscal Austerity is Accompanied byMonetary Loosening, but doesn’t have to be7200349 Consolidations Considered• Typically lower deficits than in €urozonetoday• In 24 cases growth accelerated followingthe start of deficit reduction, even in theshort run• In 13 of these cases, there weresignificant monetary expansions ordevaluations• In 11 of these cases, there were notGiudice, G., Turrini, A., in t Veld, J.(2003) “Can fiscal consolidations beexpansionary in the EU? Ex-postevidence and ex-ante analysis”,European Commission DG ECFIN
€uro Members differ in past experience of deficitreductions with / without devaluation:• Greece / Portugal needed devaluations• Spain / Italy didn’t8-4-2024-400-200020040019811982198319841985198619871988198919901991199219931994199519961997Spain (1981-97)-4-2024-400-2000200400Portugal (1986-97) Change in fiscalbalance (% of GDP)-400-20002004001988 1989 1990 1991 1992 1993 1994 1995 1996 1997-4-2024Italy (1988-97)-4-2024-400-200020040019811982198319841985198619871988198919901991199219931994199519961997Greece (1981-97)Change in exchangerate vs DM relativeto underlyingchange 1981-2002
Some €urozone Austerity Programmes areundeliverable9Program fiscal balanceas % of GDP expenditures frompeak to trough as %of total expenditurein peak yearNumber of yearsspending cut tilltroughNumber of years spendingremains less than peak yearAusterityplansPortugal 7% -13% 3 >6Greece 13% -24% 5 >7Italy 4% -1% 3 6HistoricalIreland1990s10.6% -8.7% 2 3Canada1990s9.5% -4.3% 2 2UK1980s4.3% -3.3% 4 6UK1920s3.7% -11.4% 3 6
The EU and Democracy:• 11 EU Members have been members for longer than they werepreviously democracies outside the EU• 19 joined the EU within 17 years of becoming democracies• Yet EU is mechanism for by-passing democratic pressure10CountryYear of most recentintroduction ofdemocracy*Year ofAccession toEECYears democraticoutside EU/EECPIIGSGreece 1974 1981 7Ireland 1832[?]/1922 1973 141[?]/51Italy 1948 1952 4Portugal 1975 1986 11Spain 1978 1986 8OthersAustria 1945/1955 1995 40/50Belgium 1944 1952 8Bulgaria 1991[?] 2007 16[?]Cyprus 1974 2004 30CzechRepublic1989/1993 2004 15Denmark 1945 1973 38Estonia 1991 2004 13Finland 1906 1995 89CountryYear of most recentintroduction ofdemocracy*Year ofAccessionto EECYears democraticoutside EU/EECOthersFrance 1944 1952 8Germany 1949 1952 3Hungary 1990 2004 14Latvia 1990 2004 14Lithuania 1992 2004 12Luxembourg 1945 1952 7Malta 1964 2004 40Netherlands 1945 1952 7Poland 1989 2004 15Romania 1990 2007 17Slovakia 1998 2004 6Slovenia 1990 2004 14Sweden 1907 [?] 1995 88 [?]UnitedKingdom1832 [?] 1973 141[?]
Under the OMT (“Draghi Plan”) the ECB usesits balance sheet to indirectly reduce thecosts to Eurozone Member Stategovernments of financing their debts11The EU Treaty forbids the ECB from financing Member State governments for two very goodreasons:(a) Such financing involves a form of fiscal transfer between Member Statesconducted covertly under the auspices of monetary policy.(b) Such financing is potentially highly inflationary. But don’t expect the ECB toinflate as much as the Fed or BoE!
Austerity should be mitigated by fiscaltransfers, but it is a grave error to assume“fiscal transfers” = “debt pooling”12Without conditionality:In academic studies (Gneezy, Haruvyand Yafe, Economic Journal 2004),splitting the bill => 36% higher billWith conditionality:
Countries can do more to help themselves…e.g. by showing willingness to providecollateral (e.g. gold) for bonds13Use for bonds better than ex post sales since achieves leveraged effect. Italy could covermore than two years of debt issuance with gold-backed bonds. (So could Portugal, butPortugal very likely to default, so more likely to use gold post-default, a la Cyprus.)Use of Italian gold as collateral implies no fiscal transfer, no lobster problem, no vassalproblem, and no inflation risk, whilst addressing the same “market failures”The gold in question is an Italian asset, not a German or Eurozone asset, so no fiscaltransfer is implied by its use. (But use must be approved by ECB.)Gold is a real asset, not a nominal asset, so there is no money creation and thus noinflationary pressure created by its use.The use of such gold reduces liquidity risk and reduces depreciation incentives.
Countries can do more to help themselves…e.g. by showing willingness to allow bankcreditors to take losses14If you lend money to a chip-shop and it goes bust, you’ll own a chip-shop. Same with abank.European Commission’s 2012 Bank resolution directive adds “bailin power” in respect ofbonds and deposits over insurance threshold when banks not yet bust (already existswhen they are bust)With bailins, Irish & Spanish governments would not be bust.Cypriot bank creditors losses scheme arbitrary & disrespectful of property rights – notbecause depositors lost (that was a Good Thing) but because losses imposed on largedepositors were not simply the losses of the bank. They also paid to insure the smallerdepositors (since the Cypriot government could not afford to do that). A new risk.
…but currency unions work, politically, whenongoing, decade-after-decade, fiscaltransfers are large enough15Structural & CohesionFunds€58bn / year&others€19bn extra =1% extra GDPfor Italy &Portugal =>Service OwnDebtscf cost of debt poolingTotal exposure for PIIGS = ~€1.7trEffectively taking German andFrench debt exposures to currentItalian levelsadd ~ 100bps to funding costs =>~€36bn per year
• Initiative principle wouldbe different– Structural fundsmatch funding togovt projects• Match fundingabandoned– Brussels initiative tospend => spendingsovereigntycentralised• Accompanied by tighterfiscal policy constraints– Fiscal Union Treaty /“Six-pack”– Running a non-trivial deficit needsto be approved byBrussels– => fiscal sovereigntycentralised16Complications with Ongoing Fiscal Transfers Concept• Last for decades• Real money, not“guarantees”
Two ways forward from here17Or…• Choose who’s in € and who’s not (HINT: NotGreece or Cyprus)• Deliver austerity where feasible• Pool sovereignty• Large ongoing decade-after-decade fiscaltransfers• Political unionWill this be the path they choose? Yes.Path to Single European State