The Alternative To Austerity

May 1st 2012, 14:30 by R.A. | WASHINGTON

THE backlash to the backlash against austerity seems now to be underway. For months, if not years, complaints have grown that the euro-zone's austerity-first approach to the crisis is somewhere between inadequate and counterproductive. That message now seems to be winning converts across Europe. Euro-zone leaders are increasingly acknowledging the need for a growth agenda, and the success of François Hollande in the first round of the French election is being hailed as a decisive blow against austerity. Perhaps predictably, the pushback is on. The Financial Times' Gideon Rachman captures the essence of the counterargument in a piece titled "No alternative to austerity". What Mr Rachman manages to do quite effectively is illustrate how muddled the conversation has become. He writes:

Mr Hollande says that he will replace austerity with growth. Why didn't anybody think of that before? Unfortunately, a vacuous slogan is underpinned by ineffectual proposals. Mr Hollande's programme stresses small, badly-targeted boosts to public spending, while virtually ignoring the structural reforms that are the only route to sustainable growth...

Spending on infrastructure "“ "shovel-ready" projects, as President Barack Obama has called them "“ is, of course, a standard Keynesian solution for an economy that is caught in a downward recessionary spiral. Under normal circumstances, such spending might be a great idea.

In Europe, however, there are plenty of reasons to be sceptical. If building great roads and trains were the route to lasting prosperity, Greece and Spain would be booming...

As for Italy and Spain, they are not cutting their budgets out of some crazed desire to drive their own economies into the ground. Their austerity drives were a reaction to the fact that markets were demanding unsustainably high interest rates to lend to them. There is no reason to believe that the markets are now suddenly prepared to fund wider deficits in southern Europe.

Mr Rachman does an excellent job constructing the framework through which most serious observers see the crisis. Unfortunately, it's deeply flawed. Let's start with his last point: do unsustainably high market interest rates signal a need for austerity? It would be peculiar if they did; Spain's fiscal and growth prospects aren't demonstrably worse than those in other places where markets are happy to lend cheaply. The problem, rather, is that Spain lacks its own currency and has therefore become stuck in a nasty loop in which financial concerns hurt growth and sovereign yields, and high sovereign yields lead to an austerity push which hurts growth and financial conditions.

Mr Rachman is right that, left on its own, Spain has no choice but to react to high yields by embracing drastic austerity in order to reduce its borrowing needs. The question facing Europe is not whether this is a true dynamic"”obviously it is, and it's strange that Mr Rachman would see a need to point it out. The question is whether it should be allowed"”or encouraged"”to play out, given the euro zone's deep commitment to economic integration. That's what the anti-austerity folks are complaining about. Enforced rapid, deep austerity in places that don't obviously need it entrenches a bizarre halfway integration that's ultimately doomed to fail.

What, then, are the alternatives to austerity? Well, first up would be an integration that would help break the diabolical loop now gutting the periphery. Creating a euro-zone-wide safe asset and a euro-zone-wide set of institutions to stand behind damaged banks would help accomplish that. America doesn't expect Delaware to shoulder the costs of failures of banks headquartered in Delaware. That's an important contributor to the stability of the American federal system. The euro-zone must recognise that it is the failure to build appropriate euro-zone-wide institutions"”equal in scope to the considerations and resources of the central bank"”that is contributing to soaring yields around the periphery and creating the illusion of the need for dramatic austerity in places that could do without it.

What else? Next up would be an appropriate level of euro-zone-wide aggregate demand; when the euro-zone as a whole is in recession odds are good that stabilisation policy is failing. Perhaps fiscal stimulus is out of the question, even in Germany and the Netherlands. One puzzling mistake Mr Rachman makes is in implying that the only fiscal alternative to austerity is stimulus; in fact, less austerity is also a decent option. Less austerity would be entirely appropriate in Spain, where gross debt levels remain low by rich world standards. It would be appropriate in Germany. It would be appropriate in lots of places not called Greece or Portugal. The European Central Bank should also do considerably more to support recovery, including through countercyclical macroprudential policy. Efforts to calm the financial system are lovely; they'll do little but buy time if aggregate demand is too low.

Of course, structural reforms are necessary. If the German labour market is running too hot (maybe it is; this is increasingly in doubt), leading the ECB to conclude that more easing would merely generate rapid wage inflation, then structural reforms to boost mobility across borders would be very helpful. But structural reforms are not an inseparable part of some reform cocktail that necessarily includes austerity. On the contrary, structural reform and adequate demand are two great tastes that taste great together; without some wage inflation in Germany, efforts to boost Spanish mobility won't succeed in generating sufficient migration.

I think the reaction to Mr Hollande's success is telling. The overwhelming criticism is a sort of "look how inappropriate fiscal expansion would be for the French economy" take. The point is that the economy that matters is that of the euro zone as a whole. And when one steps back and looks at the dynamics in play, it becomes clear that the robotic push for national-level austerity across the euro zone is undermining integration and thereby exacerbating the crisis.

Now of course, long-run euro-zone success depends on institutions that limit the impact of moral hazard on national budgets. No part of that sentence implies that Spain must embrace crash austerity now. Quite the opposite; crash austerity now is the best way to ensure that in the long run, the euro zone is dead.

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The alternative to the red pill is the blue pill. Just say no to the rabbit hole!

The problem with your argument is that it is a call for Germany to support Spain and Italy - perhaps indefinitely. Of course NY supports S carolina on the same basis (or the SE of the UK the North etc.) and this is sustainable because (Scotland apart) British people by and large feel like a unified people, just as different parts of the same family/village feel like a community and are willing to support each other. Unfortunately the EU citizens do not feel this way - as even people like me who think they should have to recognize.

"Creating a euro-zone-wide safe asset and a euro-zone-wide set of institutions to stand behind damaged banks would help accomplish that."

That would be a very long term project and would help nothing in the current crisis. It would require giving up a great deal of sovereignty which few countries want to do at the time.

"less austerity is also a decent option"

No, it is not. As Rachman points out, that would require paying higher interest rates. Less austerity would do nothing but create more spending on paying the interest on debt.

"structural reforms to boost mobility across borders would be very helpful."

That's another long term strategy that won't help in the current crisis at all.

"long-run euro-zone success depends on institutions that limit the impact of moral hazard on national budgets. No part of that sentence implies that Spain must embrace crash austerity now."

So how do you think the current crisis came about? The long term always shows up at the most inconvenient time. Ignoring the long run today in favor of short term success guarantees that the long run will be just as ugly as the recent past. It's like saying I'll quit drinking tomorrow but today I have to dampen this hangover.

"crash austerity now is the best way to ensure that in the long run, the euro zone is dead."

In the short run, relaxing austerity is not possible because it would raise interest rates. Solutions that will take decades to implement will help the current crisis not at all.

The Big EZ was always a political project, not an economic one, so economics will not kill it.

Reforms. If not now, when?

Enforced rapid, deep austerity in places that don't obviously need it entrenches a bizarre halfway integration that's ultimately doomed to fail.

That's an opinion, not a fact.

On the contrary, structural reform and adequate demand are two great tastes that taste great together;

"Okay Lucy, this time I'm going to kick that football through the uprights!"

without some wage inflation in Germany, efforts to boost Spanish mobility won't succeed in generating sufficient migration.

So yesterday's blog entry was a set up for this.

And you expected the Spaniards that emigrate to Germany will head back home after the "all clear" is given.

How'd that work out for the Turks?

In 2011, Prime Minister Recep Tayyip ErdoÄ?an made another visit to Germany During a speech in Düsseldorf, he urged Turks in Germany, to integrate, but not assimilate, a statement that caused a political outcry in Germany. en.wikipedia.org/wiki/Germany"“Turkey_relations

NPWFTL Regards

Theres a few faults with this argument: 1. You are looking at the health of Europe as a whole where as in practice German voters really dont care about whether Greek voters have to suffer 10 years of misery as a 'punishment' for a lack of reform in boom times. In the US people are much happier with cross state subsidies. 2. Structural reform is a pipe dream when times are good, this is part of the moral hazard argument.

Surely it doesnt take a genius to work out that you cant go on increasing your debt to GDP ratio forever? Thats the ultimate pyramid scheme, doing this is by definition temporary as eventually new sources of income must be found (particularly after your creditors stop lending you money) or some other radical solution must be found: 1. Get someone else to pay it (Your blog recommends that Germans pay everyone elses debts) 2. Default 3. Inflate debt away and then continue borrowing. 4. Find a new source of income like an easy to process commodity.

Options 1-3 are actually all one option, which is make someone else pay for your budget deficit (if you are clever it will be a mixture of other countries, creditors and your own banks), option 4 is blind luck because if you knew about the additional source of income it would already be in use.

" You are looking at the health of Europe as a whole where as in practice German voters really dont care about whether Greek voters have to suffer 10 years of misery as a 'punishment' for a lack of reform in boom times. In the US people are much happier with cross state subsidies."

But isn't that the point?

The US, politically, is more united and more able to act competently than the EU could ever act.

I wouldn't take "cross state subsidies" as a given.

Most, states have to balance their budgets. California is cutting money to colleges, resulting in those institutions have raise tuition.

As for "act competently," the fight over the last year's Continuing Resolutions (CR) and Debt Ceilings showed the compentency of the politicians of the US federal gov't.

(Just for fun, we need another CR by Sept.30th, for FY 2013.)

NPWFTL Regards

" crash austerity now is the best way to ensure that in the long run, the euro zone is dead. "