Bailout Referendum, what way would you vote?

hatrickpatrick wrote: »

To sum up: Banks aren't above everyone else. they should be treated exactly as any other business and allowed to fail just like any other business. If this means bondholders lose out, tough. It is NOT my responsibility. It is NOT your responsibility.

ei.sdraob wrote: »

It is interesting to note that its all the proponents of the kicking the can down the road solution and paying for others debts that make it out as if defaulting would be the end of the world. There will come a point when it becomes more obvious that these debts are un-payable especially if the optimistic forecasts dont materialize, then what? more denial??

K-9 wrote: »

So we'll just cut 40%, just like that and everything will be grand. Tax Revenues are already back to that level so that will drop them back another year or 2 so I suppose we can just cut again.

The Mediterranean diet for the Eurozone; Fiscal tightening is expected to be offset by rising exports
By Michael Hennigan, Founder and Editor of Finfacts
Jun 9, 2010 - 6:48:33 AM

The Mediterranean diet of vegetables, salads, and nuts has been shown by researchers at the University of Athens to reduce heart disease. The metaphor is more market friendly for the afflictions of the Eurozone economy than the term 'austerity' and in France, its equivalent has been reported to have been banned by President Sarkozy. For the EMU (European Monetary System), ongoing fiscal tightening is expected to be offset by rising exports.

Dr. Angela Merkel on Monday administered €80bn of fiscal adjustments over four years and public sector unions are reported to be planning strikes as 15,000 public sector jobs are to be cut and an estimated €30bn, or 37% of the programme will hit social spending.

"Of course the government is saying that everyone has to pay for it. But is that really justified? After all, what we're paying for is basically the financial market crisis,"said Gustav Horn of the Hans Boeckler Foundation, which is supported by German trade unions. "The German state budget was balanced in 2008 before the crisis began and the deficit came only then," Horn told State broadcaster Deutsche Welle.

"So if I would like to see people pay for it, I would of course like to see that people in the financial market sector would have to pay for it - that the wealthy people have to pay for it and not those who already don't have much money."

German Deputy Finance Minister Joerg Asmussen said all Eurozone finance ministers yesterday welcomed that Germany is meeting its obligations under the Stability and Growth Pact.

Asmussen said Germany will be able to push its national deficit below 3% of gross domestic product by 2013, as promised by Chancellor Angela Merkel’s government. He was speaking to reporters in Luxembourg.

Economists at US investment bank Morgan Stanley, based in London, say that like the other major economies, the Eurozone is now expanding again. However, the looming fiscal tightening is a potential threat to the fragile recovery. They examined the current and prospective fiscal austerity programmes of the Eurozone member countries and concluded that the overall fiscal tightening of 0.6% of GDP this year and up to 1.5% next year would reduce Eurozone GDP by 0.4% this year and up to 1% the next. However, the euro depreciation will likely offset in full the negative impact of fiscal austerity.

The effects will differ in each Eurozone country. MS recently revised up its GDP growth forecasts for Germany, Italy and Portugal (2010), down for Spain, Greece, France and Portugal (2011). For the Eurozone as a whole, MS maintained a below-consensus forecast of 0.9% this year and 1.1% the next. But despite no change in the overall GDP numbers, domestic demand might be even more sluggish, and exports stronger - - courtesy of the combined effect of a weaker currency and further belt-tightening.

What Has AlreadyChanged in the Fiscal Landscape?

Daniele Antonucci and Elga Bartsch say there is virtually no correlation between the budget balance and GDP growth. So changes in the fiscal policy stance don't matter in the Eurozone, they ask? The economists say that they do matter a great deal, but not necessarily in a mechanistic sense. Indeed, measures of public sector activity - - ranging from government consumption to the broader aggregate of government spending (which includes transfers) and public investment - - show a meaningful link with GDP growth.

The Public Sector - Is it a Key Economic Driver?

Government spending is a fairly small share of Eurozone GDP relative to, say, household spending or total investment. In 2009 it accounted for approximately 21.5% of GDP in the Eurozone, up from 19.8% at the beginning of the decade. This compares with a weight of 58.2% for household spending last year, and 19.4% for total investment. (Exports and imports of goods and services account for 41% and 40.3% of Eurozone GDP, respectively, so the share of net exports - i.e., exports minus imports - is negligible.)

However, the relevance of government spending - - and the role of the public sector more broadly - as an economic driver, either directly or indirectly, should not be underestimated. Government spending has always contributed positively to GDP growth over the past decade, unlike household consumption, investment and net trade. Since 2000, government spending has accounted for about one-third of Eurozone annual GDP growth of 1.4%, on average. Clearly, this looks set to change. With a more stringent public purse in many Eurozone countries, the chances are that government spending might even contribute negatively to GDP growth over the next couple of years. What's more, the public sector does affect the economy not only through changes in government spending. Other channels, from public investment to tax policy, are also important.

Direct and Indirect Effects - Are They Important?

Empirical evidence confirms that government involvement in economic activity does play a key role and can affect GDP growth - - though in a counterintuitive way, in some instances.

• Government consumption,i.e., government spending which buys goods and services produced in the economy and which is not a transfer payment of money collected in taxation from one group in society to another. Government consumption counts towards GDP, while transfer payments take money from some people and give it to others. Most day-to-day health and education expenditure count as government consumption. Building new hospitals is government investment; old age pensions are a transfer payment.
• Public investment,i.e., gross fixed capital formation of the general government - - -including, among other things, structures and equipment used by the military, which are similar to those utilised by civilian producers, such as docks, airfields, roads and hospitals; light weapons and armoured vehicles used by non-military units. The purchase of military weapons and their supporting systems is still part of intermediate consumption and not included in gross fixed capital formation.
• Government spending,i.e., the sum of intermediate consumption, public investments and payments for compensation of employees, subsidies, social benefits and transfers, and tax-related disbursements, among other things.

Looking at the past 20 years or so, the evidence suggests that government consumption, and, to a lesser degree, public investment are positively correlated with economic growth.

The economists say conversely, overall government spending is negatively correlated with economic growth. Although this may seem counterintuitive at first sight, one explanation could be that, in periods of weak economic activity or recessions, government spending tends to increase - - courtesy of the functioning of the so-called automatic stabilisers (such as unemployment benefits), which are quite substantial in several Eurozone countries.

Similarly, economic growth is adversely affected by an increase in government revenue (i.e., receivables on taxes, transfers, subsidies and contributions, as well as other sources - - such as privatisation receipts - - to help finance spending) as a share of GDP. For example, a tax hike will exert a negative impact on growth - - all else being equal. In this case, too, the inverse correlation seems fairly high - - at least over the 1992-2009 period under examination - - just like with government spending.

Austerity Underway - Not Just in the Iberian Economies

So, changes in the fiscal policy levers do have a non-negligible impact on economic activity. With all countries in the Eurozone set to cut their budget deficits over the next couple of years, this will undoubtedly exert a negative effect on GDP growth. However, not all will implement their belt-tightening programmes simultaneously. Apart from Ireland (the first mover on the fiscal tightening scene back in 2008), some have already started. After Greece, it is now the turn of Spain, Portugal, Italy and Germany. Others are likely to follow shortly (France, and - perhaps further down the line - - - the Netherlands and Belgium).

• In Spain, the new extra savings amount to €15bn in 2010-11. This is equivalent to about 0.5% of GDP this year and 1% next year. Measures include: abolition of ‘birth payment' of €2,500 per household, 5% cut in civil servants' wages this year and a wage freeze next year, elimination of 13,000 public sector jobs, suspension of index-linked pensions in 2011, and spending cuts at the regional level. Factoring in the announced savings into its forecasts, MS now expects the budget deficit at 9.4% of GDP this year and 6.7% the next. What's more, further fiscal austerity measures look likely, on three fronts: 1) a new wealth tax will likely apply to individuals with net worth greater than €1m - - -subject to parliamentary approval; 2) further income tax rate hikes seem on the cards; and 3) a ban on local councils from issuing long-term debt - previously planned for this year - will take effect in 2011.
• In Portugal, the new extra savings amount to approximately 1.2% of GDP in 2010 and 2.2% in 2011. Apart from bringing forward the phasing-out of all the anti-crisis stimulus measures and some tightening planned for next year, measures include: cuts in central government spending, lower transfers to local governments and state-owned enterprises, 5% wage reduction to holders of political and public management offices, introduction of motorway tolls, increase of 1pp up to the 3rd income bracket and an increase of 1.5pp for the 4th income bracket onwards of personal income tax, and a 2.5pp increase in the corporate income tax for taxable profits exceeding €2m. Factoring in the announced savings into its forecasts, MS now expects the budget deficit at 7.5% of GDP this year and 4.7% the next.
• In Italy, the Combined Report on the Economy and Public Finance (known as RUEF in Italian), published in May, had already mentioned that the government would have needed to tighten its primary budget by about 1.6% of GDP over 2011-12, in order to meet the fiscal targets mentioned in Italy's latest stability programme submitted to the European Commission - to which it reiterated full commitment. In its present form, the resulting €24bn package will include: 1) a three-year freeze on state wages; 2) pay cut for top public sector workers; 3) extra measures to curb tax evasion; and 4) delayed retirement for those due to retire next year. Factoring in an extra belt-tightening of the above-mentioned magnitude into its forecasts, MS now expects the budget deficit at 5.1% of GDP this year and 3.7% the next.

How Much More Tightening Is Needed?

Antonucci and Elga Bartsch say it all depends on what ‘how much' really means. Given the very different starting positions, the amount of consolidation required will vary significantly by country. The IMF has estimated the adjustment needed between 2010 and 2020 to bring the debt below 60% of GDP by 2030. According to these estimates, the cumulative required adjustment varies from around 4% of GDP in Germany and Italy to about 8% in France and Portugal, and 9% in Greece and Spain. And the variation in the adjustment needed to meet the Stability and Growth Pact's 3% ceiling for government borrowing might be even larger, as suggested by the annual reduction in the structural primary deficit that the European Commission believes is necessary to bring the unadjusted deficit below 3% of GDP before its deadlines.

Where Might the Extra Squeeze Come From?

The various EMU members will have different preferences in terms of the spending categories that could eventually be trimmed. Ireland spends more than average on healthcare, education (together with Portugal) and environment, housing and recreation, Italy on general public services, Greece on defence and economic affairs, Germany on social protection, and Spain on public order and safety.

What's more, further job reductions in the public sector might be considered in some countries, as was the case in Spain and Greece recently. Alternatively, there might be

further hiring freezes in the public sector, or the introduction of, say, 2:1 rules of retirements/recruitments. On this front, France is the country with the highest share of workers in the public sector (36%); at the other end of the range there's Portugal (25%).

Post-Election Tightening in the Benelux Countries...

Fiscal consolidation has so far taken a backseat in the Netherlands and Belgium. This postponement reflects, at least in part, the fall of both governments in February and April, respectively - along with the difficulty, in both countries, to form a new ruling coalition. In particular:

• In the Netherlands, the election campaign is still in full swing, with the vote scheduled for today, June 9th. Traditionally, fiscal policy has ranked quite high among the various governments' priorities, and the country has sound - and well deserved - credentials in terms of fiscal consolidation. Although the situation remains fluid on the political front and the magnitude of an eventual tightening may depend on the outcome of the election, a report by the Netherlands Bureau for Economic Policy Analysis (known as CPB in Dutch) shows that the political parties' programmes encompass cutbacks in government spending and, in most cases, increases in the tax burden.
• In Belgium, the vote is scheduled for June 13. Although the budget deficit is not particularly wide (around 6% of GDP in 2009), a triple-digit debt/GDP ratio of approximately 100% might well translate into market worries from a long-term fiscal sustainability standpoint. The election outcome will likely affect the fiscal policy outlook, at least to some degree, in this country too. But this will have to do mainly with the intensity of the belt-tightening, which looks very much on the cards regardless of the outcome of the election.

France?

The economists say harsh fiscal austerity doesn't seem to be on the cards - at least not at this stage. This sets France apart from virtually all the other Eurozone members.But its fiscal policy stance too is shifting - - albeit somewhat more gradually than elsewhere - - courtesy of the sovereign debt crisis. While it's mainly the EMU periphery that has so far been under the market spotlight, France could be affected too at some point - - should concerns spread to core countries. Indeed, the government has recently announced that, in order to achieve the goal of cutting the budget deficit to less than 3% of GDP in 2013, it will freeze nominalgovernment spending (excluding interest payments and pensions) over the next three years. But future attempts to replenish the state coffers - which MS deem to be very likely - might well entail changes in the current tax breaks and, possibly (but more difficult in the short term), the pension system.

What's the Impact on GDP Growth?

Different Country, Different Policy

Sooner or later, then, MS expects all the major Eurozone economies to go through a period of fiscal tightening. But just what impact will that have? The effects of government policy will depend on a wide variety of factors, not least the types of policy pursued by each government. Analysis based on previous periods of fiscal consolidation, including work by the OECD and IMF, suggests that income tax hikes are particularly harmful as they discourage work. Government spending cuts are thought to do less damage because they can lead to efficiency improvements. Of course, the fact that there is scope to pursue certain policies does not mean this is what governments will do, and the likely method of consolidation remains highly uncertain. On the face of it, though, a given degree of belt-tightening might be quite damaging in Greece, Ireland and Spain, due to tax hikes. Germany and France might fare a bit better, given that income taxes are unlikely to rise in the former and spending could easily be cut - to various degrees - in the latter.

The Fiscal Multiplier - A Short Review

The actual impact on aggregate demand needs not coincide with the amount of fiscal tightening. The economists say there is no consensus in the academic literature on the so-called fiscal multiplier. For example, the OECD Interlink model has a multiplier equal to 1.2 for government spending, i.e., a cut in government spending of 1pp of GDP reduces Eurozone GDP by 1.2% over one year relative to the baseline - - the effect, according to this model, is stronger in Germany and weaker in France, with Italy's response in between.

Similarly, a tax hike has a multiplier equal to -0.5, i.e., a hike in income taxes of 1pp of GDP reduces Eurozone GDP by 0.5% over one year relative to the baseline. The more recent OECD global model, however, finds a more moderate impact on GDP from a cut in government spending, to the tune of 0.8%. The various models in use at the European central banks, including the ECB's area-wide model, suggest that a cut in government spending of 1pp of GDP typically reduces GDP by 0.8-1.2%, depending on the member country.

With fiscal policy being a key economic driver, the features of the French INSEE MZE-2003 model might come in quite handy, because the published documentation explicitly mentions quarterly multipliers for government spending, as well as direct and indirect taxes. The INSEE MZE-2003 model has a multiplier equal to 0.9 for government spending, i.e., a cut in government spending of 1ppt of GDP reduces Eurozone GDP by 0.9% over one year relative to the baseline. The multiplier for income taxes is -0.3, while that for indirect taxes is -0.7.

Europe is going to have to look increasingly to the US and to the emerging economies of Asia to boost growth, Steve Clayton from Mirabaud Securities said Tuesday. "There's a large export sector, particularly in Germany, and that's going to have to play a major role in getting any sort of sustainable recovery going," he said:


So, How Much of an Impact on GDP?

Antonucci and Elga Bartsch say although details are not fully known in many cases, it seems that about half of the additional fiscal tightening in 2011 will take the form of spending cuts for the Eurozone as a whole. The remaining half will revolve around increases in income taxes and VAT rate hikes, as well as higher taxes on gasoline, alcohol and tobacco, among other things. For MS calculations, they struck a balance between the responses to the various types of tightening suggested by the models and the information available on the actual policy mix.

A fiscal multiplier equal to 0.7, i.e., the extra fiscal tightening announced for 2010 (worth about 0.2% of GDP) and for 2011 (worth about 0.5% of GDP) would reduce Eurozone GDP by about 0.1% this year and 0.4% the next. The overall fiscal tightening of 0.6% of GDP this year and 1.2% next year (in part already factored into MS forecasts) would reduce Eurozone GDP by 0.4% this year and 0.8% the next. With France and the Benelux countries likely to tighten their belts too in the second half of this year, some of the EMU peripherals to step up their fiscal consolidation efforts, the chances are that the full impact on GDP of the extra austerity measures will rise from the current estimate of 0.4% to at least 0.6% in 2011.

The Euro - How Much of an Offset?

Having reached the MS 1.24 target in EUR/USD, the economists now expect a decline to 1.16 by year-end. Further weakness in H1 2011 is expected with the EUR/USD at 1.12 - the end-2011 target has been changed from from 1.36 to 1.17. From an export perspective, however, it is not EUR/USD that matters, but the trade-weighted (TW) exchange rate. Why? Because the US is not the only Eurozone trading partner, just an important one. The UK is more important, as are Central and Eastern Europe as a whole and Asia, for example.

The euro has declined by about 12% on a trade-weighted basis since the peak in October 26, 2009, and by around 9.5% year-to-date. It is expected to drop by another 6.5% or so in the next 12 months. What's the boost to economic activity? In this case too, the answer from the various econometric models is ‘it depends on the assumptions', ranging from the characteristics of the theoretical model to the statistical method used to estimate it.

As a rule of thumb, however i.e., a 10% depreciation in the trade-weighted exchange rate boosts GDP by approximately 0.7% over one year relative to the baseline - - within the range of most central banks' and international institutions' models.

This means that the depreciation of 10% or so over the past 12 months would boost Eurozone GDP by 0.7% over the next 12 months, thus offsetting the overall fiscal tightening announced so far. What's more, MS now expects the trade-weighted exchange rate to reach a cyclical low next May - - corresponding to a depreciation of 20% from the peak in Q3 2009. Should this happen, Eurozone exports would benefit in 2012 too, all else being equal.

Putting it All Together...

So it seems that the negative impact of the looming fiscal tightening will likely find an offset in the positive impact of a weaker euro. But even if the economic outlook for the Eurozone as a whole is unlikely to change sharply, the composition of growth will likely change, and the member countries will probably be affected to various degrees.

The Q1 GDP numbers have been more robust than expected in some countries, e.g., Germany (0.2%Q versus the MS forecast of zero growth), Italy (0.5%Q versus 0.3%Q) and Portugal (1%Q versus 0.2%Q); conversely, France disappointed (0.1%Q versus 0.2%Q, consensus was more optimistic at 0.3%Q). The annual average GDP growth rate is a weighted average of the quarterly growth rates. The individual quarters have a different impact on the annual average, with the first quarter having the biggest impact on the full annual number. This means that, all else being equal, a stronger-than-expected first quarter might translate into meaningful upside risks to GDP growth.

Although the effects of fiscal austerity and a weaker euro may offset each other for the Eurozone as a whole, this does not mean that all EMU countries will equally benefit or be penalised. Export-oriented economies will experience a greater boost to GDP growth from the euro depreciation (e.g., Ireland, Benelux, Germany and Austria). Conversely, the ‘fiscal sinners' will have to tighten their belts more aggressively than average, thus experiencing a greater drag on GDP growth (e.g., Greece, Ireland, Portugal and Spain).

For the Eurozone as a whole, fiscal austerity and currency weakness will likely have a composition effect. Domestic demand, in particular household consumption, will probably turn out to be even weaker than currently envisaged - - courtesy of the current and prospective tightening. Conversely, net exports might contribute to GDP growth to a greater extent, relative to the MS central forecast, if a depreciation of the magnitude expected above takes place. The upshot is that an export-led recovery looks the only favourable outcome for the Eurozone.

All Good Then?

No, not really. The economists reiterated their below-consensus call for Eurozone GDP growth both this year and the next. Basically, even in the MS central scenario the growth impulse will come mostly from net exports in 2010, and solely from net exports in 2011. Should the above-mentioned composition effect play out i.e., stronger export contribution courtesy of the euro depreciation and weaker domestic demand contribution courtesy of ongoing fiscal austerity, the alternative scenario encompasses a recession on the domestic front next year.

What's more, the economic fallout of the banking crisis last year and the sovereign debt turmoil this year will be substantial. The growth rate of GDP is finally back in positive territory - - and might even strengthen slightly in the short term. That's good news. But the level of GDP is still quite depressed. MS expects it to reach the 2008 peak no earlier than 2012. Apart from changes in the composition of growth, a weaker currency - -- or the degree of belt-tightening currently envisaged - -- is unlikely to change the outlook.

Of course, the euro depreciation may boost inflation over time. In turn, this might help nominal GDP recover. But even in this case MS don't envisage much stronger growth, given the disinflationary pressures that fiscal austerity will exert on the domestic economy (after the initial inflationary impulse from indirect tax hikes). From this perspective, it might take until 2015 - - at best - - for Greece's and Ireland's GDP to go back to pre-crisis levels. Conversely, most other Eurozone countries might recover the lost ground by 2011, with the exception of Spain - which might take at least one more year.

Conclusions

In all, there are five main takeaways for financial markets:

• With the so-called EMU periphery having already put in place various fiscal austerity programmes, and virtually all EMU countries expected to tighten their belts at some point, the belt-tightening - - worth about 0.6% this year and up to 1.5% next year - - will exert a negative impact on Eurozone GDP growth.
• Based on MS calculations and on European Commission's recommendations, Germany, Italy, the Netherlands and Austria have less homework to do in terms of fiscal adjustment, while Greece, Ireland, Spain and Portugal will have to tighten their belts more aggressively than the ‘average' Eurozone country.
• The overall fiscal tightening of 0.6% of GDP this year and up to 1.5% next year would reduce Eurozone GDP by about 0.4% this year and up to 1% the next. What's more, the euro depreciation of 10% or so over the past 12 months would boost Eurozone GDP by 0.7% over the next 12 months, thus offsetting the negative impact of the austerity measures. And the chances are that these gains will extend to 2012.
• The effects will differ in each Eurozone country, depending on its fiscal plans, social preferences, trade openness and underlying economic strength. MS recently revised up its GDP growth forecasts for Germany, Italy and Portugal (2010), down for Spain, Greece, France and Portugal (2011).
• For the Eurozone as a whole, MS maintains its below-consensus forecast of 0.9% this year and 1.1% the next - - but the chances are that the composition of growth will be affected. Despite no change in the overall GDP numbers, domestic demand might be even more sluggish, and exports stronger - courtesy of the combined effect of a weaker currency and further fiscal austerity.

Pharaoh1 wrote: »

Is it fair to say that one of the key differences between now and the eighties (aside from the private debt burden) is that back then the increases in govt spending leading up to the crisis did not inflate things like say childrens allowance or indeed PS pay to the same degree.

I remember the cutbacks in things like hospital wards and recruitment in the PS but we did not have the difficulty of reversing social welfare or pay increases as back then we were pretty much in line with everyone else to start with.

Is this fair comment or does anyone remember differently?

Pharaoh1 wrote: »

Is it fair to say that one of the key differences between now and the eighties (aside from the private debt burden) is that back then the increases in govt spending leading up to the crisis did not inflate things like say childrens allowance or indeed PS pay to the same degree.

I remember the cutbacks in things like hospital wards and recruitment in the PS but we did not have the difficulty of reversing social welfare or pay increases as back then we were pretty much in line with everyone else to start with.

Is this fair comment or does anyone remember differently?