Friday 5 March 2010

My problem with austerirty

I have a problem with austerity. Not austerity in general (which sometimes is necessary) but the sort of austerity that Greece is now undergoing: the sort of austerity in which you raise VAT rates and cut public salaries by significant amounts with no real solution in sight. By now we are all expecting that the Greek austerity plan is just the opening act of Greece’s rescue by Germany or France or the EU or a combination of these. The austerity plan would then just be a signal that there is no moral hazard in the EU: no country is saved without taking some pain. But even if rescue is on the way, no austerity plan or bailout will change the fundamental problems of Greece’s economy and public spending. Public spending has an inertia that is based mostly on the growth of pensions and health-care. Raising taxes and cutting public salaries are one-off measures. You cannot sustain them forever. Public spending will keep on growing, taxes won’t be enough, deficits will repeat in the future. The question is: will the EU keep on saving Greece in the future? That would transform Greece into a permanently subsidized economy. There are examples of that in Europe, the most famous of them being East Germany. Is that what the Greeks want? Is that what the remaining Europeans want? There is, of course, one healthy way out of this deadlock: high growth in Greece. Unfortunately, at current productivity levels, with no independent exchange rate and monetary policies, one has difficulties in seeing how that will happen. Now fast forward a few months (weeks?), change Greece and Greeks for Portugal and Portuguese, and think about it.

1 comment:

  1. The role of ECB interventions to shore up the European money market has not been fully highlighted by the media and analysts as one of the main causes of widening on European risk premiums. Since the beginning of crisis, the ECB has decreased the quality of credit collateral in its repo-operations and other lending operations with the banking system. Basically, the banking system has been allowed to access the ECB’s standing facilities using securities with lower ratings or, even worse, with no trading at all. In simple words, the banking system has raised its finance needs through financial operations where they pump their bad assets into ECB’s balance sheet. In the end, it has effectively created an over supply of prime rated securities in the market and mostly important for European countries there has been a kind of crowding out between “toxic” banking securities and sovereign bonds. Financial investors can transform a “frog” into a “princess” through the ECB’s standing facilities so what would be the reason of buying a “princess” if you can buy much cheaper a “frog” and.…..