Note: This piece has been built on Re-Define's public call for an IMF programme for the Eurozone as published in the FT in 2012.
The IMF, historically the purveyor of crisis management for countries in financial trouble, is stuck in Europe. The IMF has, as today’s Charlemagne column in the Economist points out , become the junior partner in the ‘Troika’ arrangement and is often over-ruled, as was clear from the leaked IMF report on Greece. It was not always so.
The IMF is a body that is used to being in-charge. It has, over several decades, dictated policies to tens of countries that found themselves in a financial pickle. A visit from the IMF was an unpleasant experience and often involved a school-masterly dressing down of a country’s policy-making elite. For example, this image of the then IMF Managing Director Michel Camdessus standing, arms folded, over Suharto, appearing to dictate terms on the bailout during the Asian crisis is burned into the collective memory of Indonesians. It was even credited with helping hasten the end of the dictatorship.
Germany's pole position in the handling of the euro crisis is evident from the fact that everything is on hold until after the German elections, even as German red lines continue to define the contours of current policies in the euro area. Without Germany's economic might behind it, no solution to the euro area crisis is possible.
However, its influence on the political, intellectual and economic aspects of the handling of the euro crisis belies Germany's lack of leadership on these dimensions. The failure of intellectual leadership is perhaps the most pernicious of the three.
The absence of diversity and depth in the German debate on the euro crisis is striking. The inaccurate 'lazy southerner' narrative dominates public and private discussions, and the need for austerity is taken as a given, no matter what the evidence. 'Fuzzy' matters, such as the danger that sharp fiscal adjustment poses to social cohesion and political stability in crisis countries, get short shrift.
As the depressing economic and unemployment picture from the European Commission's growth forecasts makes clear, we at Re-Define have been right to be heavily sceptical of the current strategy being pursued by EU policy-makers.
As we warned in July 2012 in our analysis on Spain, the fiscal multipliers being used were highly underestimated. We warned that on the path being pursued, the Spanish economy and employment would be pulled downwards by a combination of fiscal adjustment and related emergent banking problems. This is exactly what has happened. Our analysis was later confirmed by the IMF, when it issued a Mea culpa on having underestimated fiscal multipliers.
This piece was written on the 14th of September and appeared as an Op-Ed in the Wall Street Journal on the 20th of September
Markets have been euphoric about the recent good news in the euro zone: the European Central Bank’s promise of potentially unlimited bond purchases, the announcement of a banking union, Germany’s green light for the European Stability Mechanism (ESM), a pro-European result in the Dutch election, and a softer EU stance on Greece.
All of this is in marked contrast to the fears of a summer meltdown that never quite happened. Could this be the beginning of the end of the euro zone’s crisis?
The Spanish Donkey, a feared torture device from the middle ages, consisted of a wedge on which the victim was seated with weights tied to his or her legs so that with enough weight, the wedge could even slice though the victim’s entire body. Arguably, the Spanish economy now sits atop such a wedge weighed down by deep austerity measures and unprecedented unemployment on the one side and by large unknown losses in the banking system brought about by a real-estate bubble that has burst on the other.
What is worse is that these two aspects weighing the economy down reinforce each other in a manner that is clearly not understood that well by EU policy makers. The Spanish economy today is at a point where every bit of austerity, measured in percentage points of GDP, leads to a reduction in demand that is even larger. So a 1% cut in government spending is likely to lead to a fall in GDP that is larger than 1%. This is because the uncertainty over the future of Spain and the fact that tomorrow, at this point, looks worse than today mean that neither consumers nor businesses are spending so a reduction in government spending translates directly into lost demand in the economy. What’s worse is that the expectation of falling GDP that accompanies such austerity means that both consumers and firms will make further cutbacks to their consumption and investment plans.