More on back-loading austerity

This is just a brief follow-up to the daily commentary on austerity. I noticed that both EC head José Manuel Barroso and PIMCO boss Bill Gross weighed in on European austerity today. And their comments support my contention that we are in the midst of a move from front- to back-loaded austerity. The policy goals remain the same, however the mix is changing to accommodate the need for growth.

First, I should note that the IMF has already moved to the back-loaded paradigm. Having done so, they have left themselves open to charges of giving contradictory advice. The IMF recommends austerity in some cases but, in others, appears to argue for greater flexibility. And this makes the organization seem inconsistent. Of course, this is a problem. And the problem comes from the fact that fiscal consolidation is not an expansionary economic policy. It causes growth to slow and increases the potential for recession.

Unless there are mitigating factors, austerity will often cause growth to slow so much that the deficit increases rather than decreases. This is what we have seen in the euro zone periphery. In an article about Barroso’s support for back-loaded austerity, the Wall Street Journal presents the figures:

Eurostat said the combined budget deficits of euro-zone members were equivalent to 3.7% of gross domestic product in 2012, down from 4.2% of GDP in 2011 and 6.2% of GDP in 2010.

The fresh borrowing needed to finance those deficits led to a rise in combined government debt to 90.6% of GDP from 87.3% in 2012.

There were very large differences between the budget positions of individual members. Germany had a small budget surplus, while Spain’s deficit rose to 10.6% of GDP from 9.4%, the highest in the euro zone.

However, that increase largely reflected the cost of bailing out the nation’s banks. Excluding those costs, the deficit stood at 7.1% of GDP, down from 9.1% in 2011.

But other nations struggling to repair their public finances also saw their deficits widen. In Greece, the deficit rose to 10.0% of GDP from 9.5% in 2011, while in Portugal, the deficit widened to 6.4% of GDP from 4.4% of GDP.

Of the four countries that have received financial help from the rest of the euro zone, only Ireland recorded a decline in its deficit, to 7.6% of GDP from 13.4% in 2011. Under its bailout program with the EU and International Monetary Fund, the government had aimed to cut the deficit to 8.6% of GDP.

So Barroso is saying that countries should be given longer to meet their deficit hurdles. Notice he is not saying they shouldn’t meet the hurdles. Nor is Barroso saying that austerity is a bad policy. He is merely saying that it has to be scaled back if it lacks social and political support due to the recession it induces. That’s all he’s saying. In effect, Manuel Barroso is saying that austerity is fine but we need to scale it back to allow for growth. That’s what back-loaded austerity is.

Bill Gross makes the same point in a different way. The FT notes that he called out the euro zone and the UK for having excessive levels of austerity. The paper writes:

“The UK and almost all of Europe have erred in terms of believing that austerity, fiscal austerity in the short term, is the way to produce real growth. It is not,” Mr Gross told the Financial Times. “You’ve got to spend money.”

Gross goes on to say that it is a mistake for the Europeans to think that bond markets are demanding austerity of the severe front-loaded kind that has been meted out in the periphery.

“Bond investors want growth much like equity investors, and to the extent that too much austerity leads to recession or stagnation then credit spreads widen out – even if a country can print its own currency and write its own cheques,” Mr Gross said.

Again, Gross here is not saying austerity is bad policy. He is saying that growth needs to be considered. This is exactly what Barroso was saying. And it is what the IMF is saying as well.

The point here is that austerity is now seen as being excessive. It is not seen as wrong. Austerity has not lost support. Front-loaded austerity has lost support. My expectation is that these kinds of policy positions will help move the ball toward an austerity stance that is more geared to lessening the economic impact over the short-term. This means there will still be a fiscal drag in Europe. But that drag will be less severe.

I continue to believe this favours Greece more than anyone else because their bonds have the most room to rally if targets are relaxed.

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