No Alternative to Austerity?

In today’s Financial Times, Gideon Rachman proclaims, without even a hint of irony (OK perhaps I am a bit tone deaf, but in this case, I don’t think so) that there is no alternative to austerity in the Eurozone.  Rachman notes further that despite the rhetorical objections to austerity now being raised by the likely winner of the French Presidential election next Sunday, the socialist Francois Hollande, even Mr. Hollande will be unable to do more than tinker around the edges of a tight fiscal policy that is being imposed by circumstances on the bloated European welfare states now comprising the European Union. Mr. Rachman is a clever fellow, and he has a way with words, and makes several good points. For example,

If building great roads and trains were the route to lasting prosperity, Greece and Spain would be booming. The past 30 years have seen a huge splurge in infrastructure spending, often funded by the EU. The Athens metro is excellent. The AVE fast-trains in Spain are a marvel. But this kind of spending has done very little to change the fundamental problems that now plague both Greece and Spain – in particular, youth unemployment. . . .

But warming to his subject, he starts to get a bit confused.

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. The “end austerity now” crowd respond that it is the responsibility of Europe’s dwindling band of triple A rated countries to go on a consumption binge and so pull their neighbours out of the mire. But the assumption of unlimited Dutch and German creditworthiness is unconvincing – as the market reaction to the Dutch failure to agree a budget, last week, illustrated.

Mr. Rachman, like most supposedly knowledgeable commentators can’t seem to get the difference between a debt crisis (which is what Greece had) and a nominal GDP crisis (which is what Spain and Italy are having). Markets are demanding high interest rates from some countries because of a risk of default caused not by overspending, which has been going on for years without causing the bond markets to panic, but because in Spain and Italy public debt is now growing faster than nominal income (which is actually contracting). The Dutch failure to agree on a budget is itself attributable, at least in part, to the fact that nominal income began contracting in the Netherlands in the last quarter of 2011 as did nominal income in the Eurozone as a whole. And if that continues long enough, then Mr. Rachman is indeed right that not even German creditworthiness can forever be taken for granted.

Mr. Rachman then widens his discussion to France:

Even in France, the centre of the revolt against austerity, it is hard to argue that the problem is that the state is not doing enough. This is a country where the state already consumes 56 per cent of gross domestic product, which has not balanced a budget since the mid-1970s, and which has some of the highest taxes in the world.

Mr Hollande, who is not an idiot, knows all this. That is why, behind all the feel-good rhetoric about ending austerity, the small print is less exciting. In fact, all the Socialist candidate is promising to do is to take a year longer than President Nicolas Sarkozy to balance France’s budget.

Mr. Rachman is no idiot either, and he is right that most European countries would probably benefit economically from shrinking rather than expanding their public sectors, allowing increased scope for the private sector to create wealth. But that long-term problem is not the source of the current crisis. What Rachman seems not to have grasped is that the address for a solution to the real crisis in the Eurozone — the nominal GDP crisis — is in Frankfurt — by some random coincidence the seat of the European Central Bank.

The ECB, seemingly in thrall to the whims of Mrs. Merkel and German inflation-phobia, is stubbornly refusing to ease monetary policy, a step that would do more than anything else to solve the Eurozone nominal GDP crisis, aka the debt crisis. In the 1930s the way out of the Great Depression was to leave the gold standard, and in every country that had sense enough to escape from the golden fetters that were imprisoning them in the Depression, a recovery started almost immediately. Escaping from the euro is now much, much harder than leaving the gold standard was in the 1930s, so it is only the ECB that can provide an escape from this crisis. But Mrs. Merkel refuses to allow the ECB to do so, and today the clever Mr. Rachman, whether intentionally or not, provides her and the ECB with a useful tactical diversion, distracting everyone from their responsibility for the ongoing tragedy now playing itself out in Europe.

15 Responses to “No Alternative to Austerity?”

  1. 1 Benjamin Cole May 1, 2012 at 12:38 pm

    Excellent blogging. It seems like monetary policy can trump austerity or heavy deficit spending, as seen in Europe or Japan.

    This leads me to conclude that monetary policy has to err on the side of promoting growth—indeed, would there be harm in a central bank single mandate, to promote real GDP growth?

    Could it be the ECB sole mandate to beat inflation dead is exactly wrong?


  2. 2 David Pearson May 1, 2012 at 1:10 pm

    When EU borrowers entered into nominal contracts, they knew full well the ECB would hold to an inflation rate target, with more emphasis on the ceiling than the floor. For this very reason, sovereign spreads experienced their infamous “convergence” in the lead up to the Euro’s launch. In other words, the expectation of Bundesbank dominance over the ECB enabled the public and private debt booms experienced in Greece and Spain. The ECB’s actions following those debt booms can therefore hardly be a surprise. Likewise, Italy has experienced tepid NGDP growth since it joined the Euro, so how can markets be surprised by this?


  3. 3 Luis h Arroyo May 1, 2012 at 1:20 pm

    Sure, I agree With you.. Up to a certain point. The point is that is too late To a general monetary expantion really efecttive, because every euro entering in Spain inmediatly goes out. So, i susppect that some dirigism of money, as a fiscal/monetised plan from north toward south is necessary in this case. I’m in a monetary policy, but taking account that money doesn’t enter easely in south countries. I’m affraid ir is a little keyenesian propposal, but i don’t see other solution.


  4. 4 Ritwik May 1, 2012 at 2:02 pm

    What should further easing by ECB look like? Almost every asset that Eurozone banks own that is worth monetizing has already been monetized. Including securitized car loans in Australia.


  5. 5 Philo May 1, 2012 at 2:17 pm

    In the long run there will be a crisis if a nation’s (nominal) debt continually grows faster than its NGDP. You evidently want to insist on a distinction between a “debt crisis” and a “nominal GDP” crisis, as follows: in the former, NGDP growth is greater than X%, in the latter it is less. You do not specify X; I would guess you have in mind a number between 0 and 2. Whatever it is, I do not see that your distinction is of any fundamental importance.


  6. 6 Marcus Nunes May 1, 2012 at 4:40 pm

    David – Merkel and Co. were very smart to push over the “austerity as solution” narrative. And Spain is the large “fall guy” after all the “austerity” it practised over the years.


  7. 7 Julian Janssen May 1, 2012 at 6:28 pm

    I am in total agreement with you on the ECB. It needs to open the taps and let the money flow. If inflation is a byproduct, it will help relieve the debt burden of government and individuals in the Eurozone…


  8. 8 David Glasner May 1, 2012 at 7:07 pm

    Benjamin, Thanks. Here’s the way I look at it. There is some rate of inflation (positive or negative) that is consistent with macro stability. That rate can go up and down; it’s not a constant. You don’t want higher inflation than that, because any increase in output and employment from incremental inflation will be transitory. On the other hand, if you get less inflation than that you will permanently lose output and employment. So the idea is to find the sweet spot that’s not too high and not too low.

    David, Well, there are reasonable expectations and there are not so reasonable expectations. I don’t believe that it is reasonable to impose German y’s preferred rate of inflation on the rest of the Eurozone at the expense of persistently stagnating nominal income and chronically high unemployment. Italy experienced tepid growth in nominal GDP after joining the Eurozone, but Italian NGDP has still not recovered the level it reached before the 2008 crisis, and it was falling in Q4:2011. That is not acceptable and it is not just surprising; it is shocking.

    Luis, And I thought that I was being pessimistic. I pray that you are not right in your pessimism.

    Ritwik, My preferred tool for monetary easing is to announce that until a predetermined price level or NGDP target is met, the ECB will aim at reducing the trade weighted value of the euro against other currencies by, say, 1% a month. But there are many variations of that basic strategy that might be adopted.

    Philo, I’m not sure how to respond. My point is that what is causing the sudden inability of various European countries to roll over the debt is not that they suddenly became overindebted, but that their income suddenly stopped growing at a normal rate. Obviously there is an interaction between debt and income, so in some sense you can’t single out one and exclude the other as the cause of the crisis. But I am saying, in the spirit of Irving Fisher, that the crisis can be dealt with more effectively by changing the time path of nominal income than by trying to reduce levels of debt (i.e., by practicing austerity).

    Marcus, Thanks for the link.

    Julian, That’s my view.


  9. 9 Tas von Gleichen May 1, 2012 at 11:59 pm

    I don’t think it is to random that the ECB is in Frankfurt. It is clearly a banking city by all means. More like the banking city of Europe. On it’s way to replace London.
    By the way, I don’t understand why the french people would vote for Mr. Hollande. In my opinion he is clearly going to make the economic situation a lot worst. Increasing taxes on the rich is not going to solve the nominal GDP issue.


  10. 10 Ritwik May 2, 2012 at 1:44 am

    David, sure exchange rate depreciation is a good strategy. But why should the Fed, PBoC, SNB, BoJ agree?


  11. 11 David Pearson May 2, 2012 at 9:17 am

    “I don’t believe its reasonable” is quite a normative statement. I think what what matters is what markets expected — reasonable or not. Sovereign spreads converged pre-Euro because markets expected the Bundesbank to force the ECB to maintain an inflation rate ceiling. The ensuing ceiling could hardly have been a surprise.


  12. 13 David Glasner May 2, 2012 at 6:55 pm

    Tas, I was being ironic. It is obvious why Frankfurt was chosen to be the location of the ECB.

    Ritwik, But the great thing about being a national central bank is that you don’t have to get permission from other national central banks.

    David, I am saying that market participants must understand that there is a risk that their expectations will be disappointed. People bought Treasuries in the 1920s on the assumption that the dollar would be tied to gold at $20.67 an ounce and other creditors lent on the assumption that they could exercise the gold clause in their contracts. For the survival of the country, it was necessary that those expectations be disappointed.


  13. 14 Ritwik May 2, 2012 at 11:16 pm


    But my point was not getting ‘permission’. When I said ‘agree’, I meant ‘accept ECB action without offsetting it in the currency market with own counteraction’.


  1. 1 David Glasner Nails the Austerity Lovers, the EU, Germany | Last Men and OverMen Trackback on April 24, 2017 at 6:25 am

Leave a Reply

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

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

Facebook photo

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

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


Enter your email address to follow this blog and receive notifications of new posts by email.

Join 3,263 other subscribers
Follow Uneasy Money on

%d bloggers like this: