European Austerity Does a 180 as Lagarde Weighs In
It will not be long before we look back on this year’s meetings of the International Monetary Fund and the World Bank, which conclude Monday, and see a turning point in the global economic crisis. Europeans, who have suffered the most, are now a considerable step closer to the right recovery policies, and Europe is likely to embrace these first.
Austerity has entered the beginning of its end. Does Europe need to clean up its messes of debt and its deficits? Most certainly and obviously, and there is hard work and sacrifice ahead. It is austerity in its undiluted form that is on the way out—austerity without ballast. This is what makes the gatherings in Washington worth noting. The agenda is taking a turn.
For years, politicians and central bankers the world over have groped to find the mix of fiscal, economic, and monetary strategies to counter the economic crisis most effectively. But it is in Europe that the confusion has been of greatest consequence. It has taken up countless summits, central bank board meetings, op-ed pages, academic papers, think-tank seminars, and who knows what else. Numerous governments have risen and fallen. Look around: At best you can get away with calling Europe’s current fate a mixed outcome.
The IMF and the World Bank, notably by way of IMF Managing Director Christine Lagarde, have put in sharp focus the core components of a recovery strategy. It focuses on two questions:
• What is the optimal degree of austerity, meaning contraction as opposed to stimulus? Up to what point is it necessary, and at what point does it become counter-productive—that is, when does it start inhibiting growth instead of fostering it? How does demand management fit in?
• How much public debt—debt as a proportion of GDP—can a nation carry when it is in or near recession? What is the relationship, if any, between debt and growth? Is cutting debt so simple as cutting spending?
Lagarde and Olivier Blanchard, the IMF’s chief economist, seem satisfied that the fund and the bank and their member nations understand the centrality of these two questions. Now, do we have consensus on them? Not by a very long way. But this is just the point.
Lagarde’s work for much of the past year—trace her steps—has been to destroy what has amounted to an artificial consensus on a set of policies that have yielded paltry results, not only for Europeans but for Europeans more than anyone else.
The problem, from London to Athens and points in between has been an overemphasis on austerity. Fiscal Times readers will be well aware of the difficulties this has caused.
Recovery policies have been too infected with ambitions for narrow political gain. Social democrats favor unworkable spending and debt levels. But conservatives have won the day, and they favor rigorous spending cuts. This is why it has fallen so much to Lagarde to dismantle the orthodoxy: She answers to no political constituency.
Based on much of what was said in Washington this last week, we are about to witness a rethink of the policies that have carried us this far. Europe will be first because its economies are the most sluggish and (in many cases) the most intractable. Consider these circumstances:
• Britain has been locked in a kind of under-the-table argument with the IMF for much of the past year. Now this is bursting into the open. In Washington, the fund called on Chancellor of the Exchequer George Osborne to ease off on the world’s most stringent austerity program. Keep May 8 in mind: That is when the IMF will send an Article IV mission—a policy surveillance team, in effect—to London. And Osborne is on his toes. On Sunday, he announced he would increase lending to small and medium-sized businesses—a move intended to appease the IMF before its Article IV crew arrives.
• French President François Hollande, a moderate Socialist, announced weeks ago that his government would shoot past its target budget deficit of 3 percent this year (landing at 3.7 percent). Now the fund, in its new World Economic Outlook, expects France to fallback into recession—this after a positive growth forecast as recently as January. The fund’s prescription: Slow down on the budget cuts.
• Both Washington and the IMF have asked Germany to take steps to enhance domestic demand to boost the more troubled of Europe’s economies. Many voices, over many months, have called on Chancellor Angela Merkel to take up such a role for Germany. Merkel is a strong defender of the euro, and she has support: Germany just approved a $13 billion bailout plan for Cyprus, for instance. But Merkel faces a tough election in September. And although she is a Christian Democrat, among her worrisome adversaries are conservatives who want Germany to do less to get Europe growing, not more.
• Over the weekend, Italian legislators voted to reinstall Giorgio Napolitano, the outgoing president, for a second term. Read this as a measure of the political paralysis that Italy suffers due to its deep divides over economic policy, debt, and reforms. The country is desperate for fresh thinking, but it is virtually unable to elevate new leadership. Italians now face the prospect of a return to power of Silvio Berlusconi, the disgraced prime minister who resigned as the Italian markets went haywire in late 2011.
These are not happy situations. Germany may or may not do the right thing by Europe. It is going to take Italy a long time to find its way. But each one is the consequence of “austerity mania,” as Paul Krugman put it in The New York Times a few days ago. Americans, we ought to note, are up against the same thing—a real jobless rate of nearly 14 percent and debt that totals 104 percent of GDP.
We have yet to conclude the same argument that bedevils Europeans. But the US is moving again in a way Europe is not, and that is its saving grace.
A lot was made of the news last week that one of the cornerstone arguments in favor of austerity had intellectual and procedural defects. This was the now-famous paper by Carmen Reinhart and Kenneth Rogoff, Harvard economists who co-related high debt with slow growth. Let us not overrate the influence of these two scholars. George Osborne was a Tory of the bluest hue long before Reinhart and Rogoff came along. The same point can be made of many in Washington.
The best way to understand this kerfuffle? It is a sign of changing times, oddly symbolic because of its timing. Call me an optimist, but there is a chance of thinking our way through the austerity question and coming out in a more beneficial place. And beleaguered Europe will be the first to take up the task.