by Frank Thomas
Dean Baker's article is valuable in illuminating the time phasing of deficits as a percentage of GDP before and after the crisis. Public and Household Debt generally always increase in recessions but rose to an extremely high level in 2008-09 recession which was really a "mini depression", now an ongoing double-dip recession for most EU countries. When Debt rises, growth falls which in turn expands Debt and thus intensifies the downward spiral of an already weak growth rate.
So adding significantly more debt when it is already so high is NOT the solution adopted to date by EU authorities as Krugman proposes. The focus for the time being is primarily on solving the fiscal problems and keeping savings high. This approach and the ongoing recession will expand unemployment as is now happening in the Netherlands (unemployment rate is now near 6% from 4.8% six months ago. But there are ample unemployment benefit funds to cover this setback. Such benefits amount to €180/day( $240/day up to maximum of ±$42,000/year) for up to 36 months ... more than sufficient to weather the double dip recession. These social nets, as I've said many times, are very important "economic stabilizers" in economic down times which America does not have.
Paul Krugman tends to underestimate the stabilizing effects of European social nets which historically have generally made recession downturns slower and less steep in mature EU countries and recoveries slower than in the U.S. But, let's face it: EU authorities failed egregiously in not enforcing the fiscal rules passed in 1991. This left Italy to go its reckless corrupt ways and left Greece, Ireland, Portugal, Spain (and Iceland) to go their reckless financial ways. Greece and Italy share the lead as being the worst tax collection countries in Europe. The ECB never paid any attention to this among other things.
Italy’s ignored public debt is at such a level that their austerity program is also being directed at politicians whose incomes are substantially above the EU average. While Italian workers’ salaries are among the lowest in Europe, monthly take-home pay for lawmakers ranges from $18,000 to $28,000 plus excellent medical insurance, a car and driver, and free travel within Italy. Little wonder Italy’s Parliament costs about $2.0 billion a year or $33 per capita for a population of 60 million. This compares to our U.S. Congress which costs about $2.2 billion a year to maintain or $7 per capita for a population of 315 million!! This underscores EU focus on weak countries getting their financial houses in order before opening the fiscal stimulus floodgates.
Carmen Reinhart and Kenneth Rogoff’s exhaustive study of recessions and the financial crises after recessions confirms that results vary broadly depending on how policy makers respond to the crisis. Their research showed that nations already at high debt levels and/or in an unhealthy financial state have historically not responded well to fiscal stimulus measures. For example, China and South Korea have recovered quicker than the U.S. and Europe because the fiscal status of these countries was far sounder before the recession hit them. In Reinhart and Rogoff’s opinion, the policy response to the banking system which caused the crisis is far more important. To make a system less vulnerable to a financial crisis, they warn there must be no hesitation in implementing and enforcing appropriate rules and regulating on the banking system. Europe is doing this now as well as seeking disciplined enforcement of a 3% of GDP deficit brake and a 60% of GDP public debt brake.
The theme in the paper, "The Real Effects of Debt," is that a country trying to go too far to buy itself out of a recession only makes the already High Debt situation and intermediate term inflation risk even worse. Better to tighten spending, reform social nets, and raise taxes progressively, support banks with longer term loans. low interest benchmark rates and, and stick as much as financially possible to planned sustainable investment projects. Name economists forget that Ireland and Iceland are now slowly recovering from economic disaster with the former receiving modest support from the ECB and the latter practically nothing (except some aid from Norway).
The following ratios of Debt as a percentage of GDP come from the Federal Reserve Bank paper. They are alarming, and the Debt mix management problem is quite different for most countries:
TABLE 1
.......................................1980......1990......2000......2010
Government debt
U.S...................................46%.......71%......58%.......97%
U.K...................................58%.......42%......54%.......89%
Germany...........................31%.......42%......54%.......77%
France..............................34%.......46%......73%.......97%
Italy...................................54%.......93%....126%.....129%
Netherlands......................65%.......97%......67%.......76%
Spain................................27%.......49%......71%.......72%
Greece.............................26%........83%....124%.....132%
TABLE 2
Household Debt
U.S..............................52%........64%......74%.......95%
U.K..............................37%........73%......75%......106%
Germany......................50%........61%......73%........64%
France.........................27%........46%......47%........69%
Italy................................6%........21%......30%........53%
Netherlands.................43%........49%......87%......130%
Spain...........................24%........41%......54%........91%
Greece...........................8%.........9%.......20%........65%
TABLE 3
Non-Financial Debt (Corporate Debt)
U.S..............................53%........65%.......66%.......76%
U.K..............................64%........88%.......93%......126%
Germany......................46%........35%.......91%.....100%
France.........................99%.......106%.....123%.....155%
Italy..............................48%.........66%.......96%.....128%
Netherlands.................98%.......119%.....140%.....120%
Spain..........................120%.........97%.....133%.....193%
Greece.........................59%.........47%.......51%.......65%
One can quickly see why the Netherlands is undertaking a sharp five year budget reduction of €23-26 billion particularly with its very high household debt ratio ... which is also very high for U.S., UK, and Spain but surprisingly low for Greece.
U.S., France, Italy, and Greece have very high government debt ratios. Non-financial debt ratios are extremely high for Spain and France and rather high for all other countries, but very low for U.S. and, again surprisingly, very low for Greece.
The Federal Reserve Bank paper concludes after exhaustive study that certain thresholds should not be exceeded for the three forms of debt above. These thresholds are: 85% for government debt; 85% for household debt; and 75-90% for non-governmental debt. The research paper concludes that going above these thresholds begins to have a significant impact on GDP growth.
This is a main factor behind the EU's reluctance to print large sums of money now or purchase excessive bundles of bad debt. The next step is to come to agreement on some innovative bail-out funding solution for the ECB that is financially responsible ... while still holding both financially weak and strong countries to the agreed fiscal discipline rules.
- reducing very high government or household debt among EU member countries noted in TABLE 1
- achieving real EU 17 and EU 27 fiscal unity including: consistentcy and harmonization in financial reporting, transparency, and effective operation/enforcement of EU rules for government deficit and debt levels
- implementing Basel III stricter capital (equity) reserve requirements for banks of 3% of total assets among other provisions
