Saturday, September 29, 2012

Austria and the EU fiscal suicide pact

Austria's ratio of sovereign debt to GDP is up to 74.4%. (Staatsschuld wächst rasant Oberösterreichisch Nachrichten 29.09.2012)

Angela "Frau Fritz" Merkel's fiscal suicide pact - which Austria has approved with support from the ruling Social Democratic and conservative coalition parties - requires a maximum ratio of 60%. The treaty is more formally called the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union, or the Stability Pact for short. It aims, in the language of its preamble, "to ensure that their deficits do not exceed 3 % of their gross domestic product at market prices and that government debt does not exceed, or is sufficiently declining towards, 60% of their gross domestic product at market prices."

The fiscal suicide pact enters into force as soon as 12 eurozone members approve it. (Title VI.14.4) As of now, 11 EU members have approved, not all of them eurozone countries. (Consilium Ratification Details, accessed 29,09,2012.)

The French unions are scheduled to demonstrate against French ratification of the fiscal suicide pact on Sunday, Sept. 30. Socialist President François Hollande was elected earlier this year on a demand to renegotiate the pact, a promise that he barely went through the motions of pretending to keep. (Leo Klimm, Frankreichs Präsident der Schmerzen Financial Times Deutschland 26.09.2012) In exchange for cosmetic promises from Frau Fritz to support infrastructure investment, he quickly capitulated once in office and agreed to support the fiscal suicide pact. Parliamentary approval isn't entirely assured, though. The Socialists' coalition partner the Greens has decided to oppose it, prompting Danz Cohn-Bendit, probably their best-known leader internationally, to resign from the party. While I understand his long-time commitment to the "European project", this fiscal suicide pact is just a bad idea.

Austria's case right now illustrates why. If the pact takes effect on January 1, since Austria's deficit is above the arbitrary 60% ratio, they would be required to immediately begin reducing their debt ratio by 1/20 per year. (Title III.4) But Austria's economic growth is slowing along with Germany's and a new recession is likely. While one-twentieth initially doesn't sound like a lot, it would require immediate adoption of austerity measures (cuts to government services, increasing taxes) at the start of a new recession in the middle of the general European depression - exactly the opposite of what fiscal policy would need to be!

This fiscal suicide pact is pure Angie-nomics.

Going back to Austria's case, adopting contractionary fiscal policy during a recession, Herbert Hoover economics as it is, would be a pro-cyclical measure making the recession worse. As the economy shrinks, the debt-to-GDP ratio gets worse, requiring more pro-cyclical cuts under the fiscal suicide pact. And once this starts happening, Austria's borrowing costs could spike (the bond vigilantes!) and they could find themselves in the position of Spain and its other partners in misery, having to ask for EU bailouts to meet their financial obligations and subjecting themselves to even more drastic Angie-nomics austerity measures.

As Argentine President Cristina Fernandez told the UN General Assembly this past week, a country needs economic growth to be able to service its debt obligations. "Los muertos no pagan sus deudas," as she put it. ("The dead don't pay their debts.")

No wonder Paul Krugman calls it Europe's Austerity Madness New York Times 09/27/2012:

... the purveyors of conventional wisdom forgot that people were involved. Suddenly, Spain and Greece are being racked by strikes and huge demonstrations. The public in these countries is, in effect, saying that it has reached its limit: With unemployment at Great Depression levels and with erstwhile middle-class workers reduced to picking through garbage in search of food, austerity has already gone too far. And this means that there may not be a deal after all.

Much commentary suggests that the citizens of Spain and Greece are just delaying the inevitable, protesting against sacrifices that must, in fact, be made. But the truth is that the protesters are right. More austerity serves no useful purpose; the truly irrational players here are the allegedly serious politicians and officials demanding ever more pain. [my emphasis]
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