One Austerity (Should Not) Fit All
The run up to the Italian elections in February is a welcome occasion to come back to the issue of austerity. The debate in Italy was fired by the widely discussed Wolfgang Munchau editorial, blaming Mario Monti for not opposing austerity. In the heat of electoral competition, this unsurprisingly stirred harsh discussions on whether Italy has room for reversing the austerity that ravaged the country. Some commentators got slightly carried away, accusing those opposing austerity of “silliness and falsehood”. I wonder whether they include the IMF chief economist in the bunch… Whatever, this is a minor issue; the way I see it, these discussions totally miss the point.
The Italian problem is not a problem of Italy. It is a problem of the EMU, and as such it should be addressed. One may argue that Italy today has no room for a fiscal expansion. For example, Olivier Blanchard at the IMF press conference last Wednesday:
…there’s little question that fiscal adjustment […] have had adverse effects on activity. And indeed, if our assessment of multipliers was, in fact, higher than we had assumed, then the effect was probably more adverse. The question is whether there was an alternative to it. I think if you go back to where Italy was not very long ago, there was enormous market pressure for Italy to actually do fiscal consolidation. There were questions as to what would happen if Italy didn’t do it. I think Italy is one of these countries in which there was little choice about the need and the pace of fiscal consolidation. And if we look at where Italy is now, clearly the adjustment has been painful.
One may disagree with Blanchard, and I do certainly believe that something different could and should have been tried in the past two years. But he certainly makes a reasonable point. Let’s assume for the sake of argument that he is right, and that Italy had little choice. Still, if I were a journalist attending the press conference, I would have asked him the real question: what should Germany have done? And I would have been very curious to listen to his answer…
As a matter of fact, even assuming that that Italy and other peripheral countries had little or no room for supporting their economy, the same could not be said about the Eurozone as a whole. I plotted the 2012 fiscal stance of EMU countries the, “fiscal impulse”[*], against the output gap in 2011 (the choice of 2011 allows to roughly interpret the fiscal impulse of 2012 as a reaction to economic conditions in 2011). The size of bubbles is public debt, for which I used the latest Eurostat data (2012Q3).
Let’s see how to read this chart. Countries in quadrant I implemented countercyclical policies in 2012: they produced below potential in 2011, and had a positive fiscal impulse. Likewise, Germany, in quadrant III, implemented a fiscal restriction facing a positive output gap (I have a hard time writing that they were overheating…). Most EMU countries are in quadrant IV, meaning that, facing a deteriorated macroeconomic outlook, they went for procyclical austerity policies. Notice that the size of bubbles shows no real correlation between austerity and troubled public finances; in particular, the EMU as a whole has a debt ratio of 90.1%, well below the United States (I do not even mention Japan); and yet it falls into the fourth quadrant, meaning that today it is implementing procyclical recessionary policies. This is the real problem we are (or should be) debating today in Europe. Not the Italian austerity. This brings me back to Munchau’s piece. If commentators had read it more carefully, they would have remarked that on the issue of Italy’s austerity he says almost nothing. Here is his main criticism of Mario Monti:
…But Mario Monti, Italy’s prime minister, did not stand up to Angela Merkel. He did not tell the German chancellor that his country’s continued engagement with the single currency would have to depend on a proper banking union with full resolution and deposit insurance capacity; a eurozone bond; and more expansionist economic policies by Berlin. (emphasis added)
The problem is not Italy (or the periphery in general). The problem is Germany. It is tiring to repeat it over and over again, but Berlin is not doing its homework.
Let’s take Blanchard’s stance, and assume that Italy, Greece, Ireland (its bubble is below Greece), cannot afford to reverse austerity; let’s also put in the pack Spain, that in spite of a low debt ratio has a serious problem with its banking sector. Common sense should dictate that at least the low-middle debt countries move up along the vertical axis, reversing austerity (Netherlands, Slovenia, France), or implementing more significant stimulus measures (Austria Finland).
Would it be enough? Of course not, unless Mrs Merkel does something. Germany is technically doing the right thing, cooling its economy (although the IMF estimates its output gap to become negative, at -0.25%, in 2013). But if solidarity were not an empty word, if the word Union in the EMU acronym actually meant what it means, Germany could also implement a fiscal expansion, lifting the Eurozone into quadrant I. This would imply, for the EMU as a whole, a countercyclical aggregate stance, and a more accommodating environment for the countries forced to implement austerity measures.
Will this happen? Well, let’s see… For what they are worth, the IMF provides forecasts of the fiscal impulse into 2013, and this is what they look like
Not a single one of the countries that can afford it, in 2013 will implement expansionary policies. Not one. Time passes, but it seems that the bulk of the problem remains the one I pointed out in my first post, ages ago: Symmetry and solidarity. The burden of the adjustment was, is, and will be, only on the shoulders of the weak countries. This is not only unfair, but also self-defeating. The acute phase of the crisis may be over, but if things go on like this, we are in for a lost decade of stagnant growth.
I dare not imagine what will this do to the already shaky European project.
[*] The fiscal impulse is computed as the negative of year on year changes in cyclically adjusted government net lending. In other words, it takes away cyclical changes in the deficit that are due for example to automatic stabilizers. The fiscal impulse is a rough measure of the discretionary fiscal stance of the country, or the stimulus. A positive number denotes an expansionary stance. [back]