Relentless austerity will only deepen Greek woes

by Wolfgang Münchau

Financial Times
October 7, 2012

We have reached a point where the policies adopted to resolve the eurozone debt crisis are causing more damage than whatever may have caused the problems in the first place. This is painfully obvious in Greece and increasingly so in Spain.

The troika of the International Monetary Fund, European Commission and European Central Bank is now demanding that Greece front-load austerity measures for 2013 on the grounds that the country is certain to miss the nominal deficit target for 2013. The Greek government had forecast a fall in gross domestic product of “only” 3.8 per cent, but the troika believes the fall in GDP is more likely to be of the order of 5 per cent, according to the Greek newspaper Kathimerini. That would imply that Greece will miss the overall goal of a primary surplus (the surplus before the payment of interest on debt) next year.

Why is Greek GDP falling so fast contrary to what official forecasts have claimed? The global economic outlook might not help. But the Greek economy’s year-in, year-out annual shrinkage of a magnitude of 5 per cent is caused primarily by the relentless pursuit of nominal deficit targets. If the economy misses the targets, more austerity is applied, which causes a continued fall in GDP, followed by another failure to meet the target. In other words, the troika is demanding policy action whose effect will be a further deterioration in the Greek economy, and thus a further deterioration in the debt ratio, which in turn requires further policy action of the same self-defeating kind.

Spain is not quite there yet but it is heading in the same direction. Luis María Linde, governor of the Bank of Spain, last week told the budget committee of the Congress of Deputies that Spain risks missing this year’s deficit target. He recommended that the government adopt further austerity measures to make up for this shortfall. Since nobody, including presumably Mr Linde, believes in the Spanish government’s optimistic prediction of a 0.5 per cent fall in GDP next year, the probability of a large shortfall in the 2013 deficit is close to 100 per cent. As in the case of Greece, there is a dynamic at work in Spain where policy makers are chasing a nominal target, piling on one austerity programme over another, and then missing it by a wide margin.

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