Breaking the Eurozone's Self-Defeating Cycle of Austerity
While a beleaguered IMF and ECB try to hold the line,
voters all over Europe are rebelling against their
punitive fiscal orthodoxy
27 April 2012
It has become a ritual: every six months, I debate the
IMF at their annual meetings, the last two times
represented by their deputy director for Europe. It
takes place in the same room of that giant greenhouse-
looking World Bank building on 19th Street in
Washington, DC. And each time, the IMF's defense of its
policies in the eurozone does not get any stronger.
Maybe, it's because most economists at the IMF don't
really believe in what they are doing. The fund is,
after all, the subordinate partner of the so-called
"troika" - with the European Commission and the European
Central Bank (ECB) - calling the shots. And most fund
economists know their basic national income accounting:
fiscal tightening is going to make these economies
worse, as it has been doing. Those that have tightened
their budgets the most - for example, Greece and Ireland
- have shrunk the most, as would be predicted.
The Spanish government, which on Friday announced a 52%
unemployment rate among its youth, has projected that
the planned budget tightening for this year would by
itself take 2.6 percentage points off of 2012 growth.
With the eurozone and now even the UK in recession, with
the German economy shrinking and France barely growing,
the rebellion against the self-inflicted harm of
austerity is spreading to the richer northern countries.
In the Netherlands, which is also in recession, the
government fell this week after failing to get its
austerity package through parliament. The irony of this
happening to one of the most pro-austerity governments
in Europe was not lost on the continent.
In France, parties described by much of the media as
"extremes of the left and right" captured a record 30%
of the vote. In reality, the Left Front candidate, Jean-
Luc Mélenchon was not extreme by any rational measure.
On the contrary, he won 11% of the vote because he
opposed the extremism of the "mainstream", which pledges
to plunge France into recession and vastly increase
unemployment by attempting to balance its budget in the
next few years. Mostly likely, he could have won much
more, if not for the fear among left-of-center voters of
giving incumbent Nicolas Sarkozy a boost by winning the
As for the far-right National Front's record showing of
19%, they are, indeed, extreme in their hostility to
immigrants. However appalling their strength, though,
one should not assume that this was the main issue in
the minds of all of their voters. One poll of their
voters showed 78% wanted a return to the French franc.
The party's candidate, Marine Le Pen, also campaigned
against the euro and against European integration.
This is another irony that many liberals and even much
of the left do not wish to acknowledge: by implementing
a monetary union that is based on neoliberal principles
and rules, the eurozone may have undermined European
solidarity and even the potential for further
integration. The current structure and leadership of the
eurozone seeks to adjust the imbalances brought on by
the run-up to the world financial crisis and the 2009
recession by putting the burden of adjustment on those
who can least afford it.
This has huge social costs. It is also attempting to
accomplish something that is painful and probably not
possible - an "internal devaluation" in Spain, Portugal,
Greece, Ireland and Italy; and "growth through
austerity" in France. One result is not only the
backlash against immigrants, which is often an ugly
side-effect of recessions and prolonged unemployment,
especially when politicians fan the flames, but also a
greater friction between countries than we have seen for
some time in Europe.
On the economic front, Europe faces two immediate
problems. The first is the possibility of an acute
financial meltdown, of the type that followed the
collapse of Lehman Brothers in 2008. The ECB under Mario
Draghi, who took over in November 2011, has seemed to
want to avoid the near-death experiences of last year.
By pumping more than 1tn euros into the banking system
since December, the ECB has reduced the probability of
an acute banking crisis.
The second crisis is the recession itself. And as the
recession drags on, and the European economy worsens,
the possibility of a more severe financial crisis
increases. Draghi was unusually pessimistic this week:
he noted that the eurozone was "probably in the most
difficult phases" of a process in which fiscal austerity
was "starting to reverberate its contractionary
From Draghi's remarks this week, it seems that he, too,
may not believe in what the European authorities are
doing. But the European Central Bank is not willing to
do what would end the crisis most immediately. The ECB
has the ability to buy the bonds of troubled eurozone
countries, and can create the money to do so - just as,
in the US, the Fed has created some $2.3tn since 2008
and used it to buy long-term US treasury obligations.
The ECB could thereby put an end to the threat of an
acute crisis in Europe, and remove countries like Spain
from the self-defeating cycle of cutting spending and
shrinking their economies in a futile attempt to lower
their debt burden. (Indeed, the credit-rating agency S&P
just lowered Spain's bond rating, and it appears that it
did so because of the damage that it expects Spain's
economy to suffer from the budget cuts that are,
ironically, supposedly intended to mollify the bond
The ECB could put a ceiling on the interest rates of
Italian and Spanish bonds (the countries whose debt is
too-big-to-fail) by simply committing to buy these bonds
whenever yields are above, say, 2.5%. By doing this,
they would cut off the possibility of these countries'
interest burdens spiraling to unsustainable levels, and
ending up like Greece's.
Of course, the European authorities would also have to
change direction and support counter-cyclical policies
in the countries that are already under IMF agreements -
Greece, Portugal and Ireland - as well as the rest of
Europe. But all of this is quite feasible - with the co-
operation of the ECB.
There are some who say that the ECB doesn't have the
legal authority to do this, but there are few legal
restrictions on them. As Draghi noted last year,
maintaining "price stability" includes intervening
against the threat of deflation, as well as inflation.
That is enough of a rationale to resolve Europe's
financial crisis through the obvious means available.
It is only the political will that is lacking. In the
meantime, the opposition of ordinary Europeans
throughout the eurozone will be all that stands between
the European authorities and a worsening economic mess.
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