Hopes Lift as Europe Shifts

austerity-europe3

Europe is finally shifting its priority from fiscal austerity to growth.  After a few years of harsh spending cuts, eurozone-wide budget deficits fell from a peak of 7 percent in the third quarter of 2010 to below 4 percent at the end of 2012.  During that same time, growth went from positive to negative and unemployment reached a record high 12 percent.  Three years into the eurozone crisis, spending cuts and revenue increases have little to show, and European leaders are beginning to shift away

Recent events have signaled and supported this shift.  A major pro-austerity study widely cited by policymakers has been tarnished due to errors found in the study, a voter revolt in Italy that loudly rejected austerity provided a major setback, and José Manuel Barroso, president of the European Commission, said that austerity has “reached its limits” and conceded that it does not have enough political and social support.

In addition to aggressive monetary policy by the European Central Bank (ECB), these recent events have encouraged hope in financial markets.  Previously, the ECB’s willingness to do “whatever it takes” to save the financial system bought much needed time for eurozone policymakers to get their economies growing again, but their emphasis on austerity has done little to achieve that goal, creating an especially delicate dynamic between financial market performance and that of the real economy

As Europe is now recognizing that it is finally time for a shift in policy, and also as new center-left leadership takes the helm in Italy after a shaky leadership transition, yields on Italian and Spanish ten year bonds have fallen to their lowest levels since November 2010, and European stock markets are outperforming on the hopes of a rate cut by the ECB (which is an expansionary/spending friendly policy). 

Of course, the only positive signs seen so far in this shift are in market expectations that reduce the cost of borrowing for hard hit eurozone countries, but it is yet to be seen if policymakers will be effective in their shift to ‘pro-growth’ stimulus policies.  After all, despite lower borrowing costs for Spain and Italy in particular, yields for German bonds have gone down as well, so the spread between Italian and German bonds (how much riskier the Italian government is than the German government) is still almost just as high as it was before these recent developments.

After three years of austerity driven policies with nothing to show, this shift in policy is welcome.  Now that borrowing costs are relatively low, thanks to this shift in policy but also largely to the ECB, it is a very appropriate time to spend now, encourage real economic growth and employment, and to save later (this is what economists call countercyclical policies). 

The whole world is hoping the eurozone reaches the end of its dark tunnel, and the policies that will help it get there can be a lesson for the rest of the world as well.  I hope policymakers in Washington will pay close attention.

 

Advertisements

Join the discussion

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: