But it gets worse. The reduced ability for Europeans to payback debt also means that risk premiums on countries with lots of debt or ones perceived to have debt problems increases, further raising these country’s debt burden with higher financing costs. The fiscal crisis gets bigger, and being easy to observe, gets wrongly credited as the cause of the Eurozone’s problems. Consequently, the Eurozone crisis is prescribed with the fiscal solution of austerity. The real solution, however, implied by the monetary view of crisis is restoring nominal incomes to their originally expected values. Thus, David Glasner argues that “Europe is having a NGDP crisis not a debt crisis” and Ambrose Evans-Pritchard claims that the Eurozone crisis “is a monetary crisis caused by a jejune central bank [.]“
This figure shows a remarkably strong relationship between (1) the deviation of nominal income from its expected level and (2) the growth of the debt burden lagged by four quarters. Thus, if European nominal incomes are less than expected then eventually higher debt burdens increase for the reasons outlined above.
Now lest you think the strong relationship is simply the result of nominal GDP being in the denominator of the the debt burden measure take a look at the following figure. It shows actual nominal GDP for the Eurozone and its trend for 1995:Q1-2006:Q4 which are used to construct the percent deviation of nominal income from its expected level in the figure above. The trend provides an indicator of what nominal income growth expectations were prior to the 2008-2009 crisis.
Update: Martin Wolf similarly notes that for many of the crisis-stricken countries in the Eurozone, their fiscal positions did not look that bad prior to the crisis:
Take a look at the average fiscal deficits of 12 significant (or at least revealing) eurozone members from 1999 to 2007, inclusive. Every country, except Greece, fell below the famous 3 per cent of gross domestic product limit. Focusing on this criterion would have missed all today’s crisis-hit members, except Greece. Moreover, the four worst exemplars, after Greece, were Italy and then France, Germany and Austria. Meanwhile, Ireland, Estonia, Spain and Belgium had good performances over these years. After the crisis, the picture changed, with huge (and unexpected) deteriorations in the fiscal positions of Ireland, Portugal and Spain (though not Italy). In all, however, fiscal deficits were useless as indicators of looming crises (see charts).
Now consider public debt. Relying on that criterion would have picked up Greece, Italy, Belgium and Portugal. But Estonia, Ireland and Spain had vastly better public debt positions than Germany. Indeed, on the basis of its deficit and debt performance, pre-crisis Germany even looked vulnerable. Again, after the crisis, the picture transformed swiftly. Ireland’s story is amazing: in just five years it will suffer a 93 percentage point jump in the ratio of its net public debt to GDP.
Comments are closed.