Letter from Europe: Austerity is fast becoming a dirty word

Policy response EU bigwigs have pinned their hopes to is under pressure


L’austérité ne marche pas ,” reads the headline in Aktuell , the monthly magazine of Luxembourg’s biggest trade union. The simple catchphrase – “Austerity does not work” – is emerging as something of a rallying cry across Europe, amid public disaffection with Europe’s response to the economic crisis.

Crushing unemployment figures and persistently stagnant GDP data are putting Europe’s policy response under the spotlight. Austerity – technically, an economic policy response whereby governments reduce their budget deficit through a combination of spending cuts and tax rises – is first in the firing line, as ordinary Europeans begin to lose patience with a policy that many believe has yet to yield benefits.

The last 10 days may be remembered as the point when that policy response began to shift. First, the theories of Harvard academics Carmen Reinhart and Kenneth Rogof, whose work on government debt and economic growth have informed governments’ response to the crisis, were called into question. While admitting to a coding error, the duo stood by their conclusions. Still, the damage was done, as the question marks over the research, much valued by EU economics commissioner Olli Rehn, left the euro zone’s policy of austerity on shaky intellectual ground. The controversy also bolstered the views of many citizens, who feel their criticism of the euro zone’s austerity policy has been falling on deaf ears.

IMF unease
The Reinhart-Rogof controversy unfolded in a week when many of Europe’s top officials and political leaders had decamped to Washington for the annual IMF and World Bank spring meetings. While not quite enemy territory, the IMF has increasingly moved into the European Union’s orbit since the onset of the euro zone crisis through its involvement in the various bailout programmes. The relationship is not always a comfortable one. The IMF used the occasion as an opportunity to reiterate its criticism of Europe’s response to the crisis. The Washington-based body trimmed its forecast for global economic growth, and urged European policymakers to use “aggressive” monetary policy, with its chief economist coolly pointing out that the main challenge is “still very much in Europe”. As a result, European policymakers, such as euro group head Jeroen Dijsselbloem, appeared to be on the back foot as they set out their economic wares to US audiences.

Comments by European Commission president José Manuel Barroso at a conference on Monday which suggested that austerity might have reached its limits, reignited the debate. This was followed by the publication of sobering economic data which showed that output continued to contract in the euro zone, with Europe’s star pupil, Germany, experiencing a surprise drop.

The closely watched figures are a serious indication of the challenges that are facing the euro zone economy, prompting expectation that the European Central Bank may cut interest rates at next week’s governing council meeting.

So are Barroso’s comments a sign of a sea-change in EU economic policy?

His remarks, importantly, were delivered off the cuff, though, like Dijsselbloem, who said in an interview that future bank bailouts would involve a burden on private investors, he may be simply letting the cat out of the bag and stating what is official euro zone policy.

In addition, EU economics and monetary affairs commissioner Olli Rehn has already appeared to soften his stance on budget deficit targets.

A change in economic policy could have major political ramifications across Europe, giving hope to countries, including Ireland, that the deficit-reduction focus of budgets may be eased. The likelihood that many euro zone countries, including behemoths like France, will miss the deficit-reduction targets set by the European Commission has strengthened the argument for relaxing strict budget consolidation rules.

Germany calling
But the main barrier towards a reversal of policy is likely to be Germany.

As the leading proponent of strict budget discipline within the euro zone, the key question will be how far Germany is prepared to shift on its entrenched fiscal policy position.

Even if this week’s poor economic figures provide a wake-up call to the country about its own economic vulnerability, surrendering ground on the principle of fiscal consolidation will be difficult to achieve in an election year.