European sums don’t add up
At the G20 meeting this weekend, Barack Obama will admonish the Europeans for their austerity fetish.
The US is fed up of being the consumer of last resort, providing external demand for other countries that run competitive macroeconomic policies, using exports to the US to grow their economies. China manages its exchange rate. Germany keeps wages and prices low. The UK has undertaken a competitive devaluation against the dollar over the last two years.
Now Europe wants to add a severe fiscal tightening to the pressure on the US. The UK is embarking on a fiscal squeeze of £113 billion squeeze over five years. Germany plans to cut €80 billion over four years, to return to the stability pact rule restricting deficits to 3 per cent of GDP. The other two largest economies in the euro zone, France and Italy, will cut €70 billion and €25 billion each. In Italy’s case, this may not be enough, as it has such a large stock of debt built up in good times – but do the others have room for manoeuvre?
There is uncertainty on either side. Sovereign debt markets are prone to sudden stops. Government debt can crowd out lending to the private sector. But surely the pace of this tightening is highly risky – a clear plan for cuts, staged over a longer period, would help to stave off deflation. German, French and UK debt is still at pre-crisis levels, partly because banks are still risk averse, preferring governments to companies.
The size of the cuts France, Germany and the UK are considering impose large costs on their own and others’ economies. The UK is tightening by 8 per cent of GDP; France by 4.3 per cent, and Germany by 3.5 per cent. France and Germany are going to cut €150 billion out of the eurozone economy by 2013. According to IMF GDP forecasts, which were made in March before the draconian cuts were announced, total eurozone growth will be €394 billion in those three years. The IMF had already priced in some of this. But such an enormous sum cut so quickly will add deflationary pressure to an economy already struggling with very low inflation.
Berlin argues that a “stability-orientated” fiscal and monetary policy, which keeps expectations about sovereign debt yields and inflation anchored, is the best way to restore a degree of certainty to markets. This may be true in normal times – but with the ECB’s broad definition of money, M3, back down to 0, deflation looks more likely. Now, monetary policy is going to have to do it on its own: here’s hoping the ECB keeps the taps flowing.