The debate between moving towards austerity and continued spending to fuel growth is heating up in Western Europe. So far the supporters of austerity are struggling to make a solid argument for tightening the spending. Spain is an example of a country that is implementing austerity measures and at the same time they slipped into a double-dip recession as unemployment continues to surge. Not only has the GDP of Spain turned negative, the interest rates they must pay to borrow money have also increased. Wasn’t the goal of moving towards austerity that interest rates on government bonds would decrease allowing the country to borrow money at a cheaper rate? In theory that sounds like it should be the outcome, but as we have experienced, it is not the case in the short-term.
The flurry of downgrades of the European sovereign debt by the rating agencies has led to lenders to demand higher interest rates. This increase in interest rates in Spain, Italy, France, and other countries has increased the amount of interest that must be paid on the money borrowed. As the interest payments increases, the deficit for the borrowers and results in a higher debt-to-GDP ratio.
On top of hurting the debt situation, higher interest rates could have a secondary affect on the overall economy. As rates increase it will hamper any borrowing from the governments that could be used as a fiscal stimulus for the economy. At the same time the rates for the companies based in the country will typically increase and could slow down corporate expansion, potentially leading to contraction. In the end, higher interest rates will hamper economic growth in a given country.
When it comes down to it, growth is the real problem. Yes, Western European countries along with the U.S. are spending too much money on frivolous projects, as has been the case for decades. But recently the spending has increased at a rapid pace in which growth has not been able to keep up. When the spending outpaces growth it results in an increase of debt-to-GDP ratio that leads to ratings agencies questioning the creditworthiness a country. This is exactly what happened over the last few years.
With growth being the real problem for Europe the focus should be on increasing growth and at the same time reeling in spending. This does include some austerity or as I like to refer to it, fiscal commonsense. Countries need to cut back unwarranted spending that does not lead to growth and use the money they have to spend on projects that will increase growth in the future. This plan will actually take a lot of work and understanding of the economy. Unfortunately, it may be too much for many of the politicians in Europe and here in the U.S. The governments are painting the situation at black and white, when in reality the global economy is in the greyest of areas today.
The only way for politicians to be able to look at the issue from my viewpoint, is when they realize it was not solely high debt levels that caused the global financial crisis. It was the perfect storm of slowing growth combined with rising government and household debt levels. As complicated as the financial crisis was, the only solution will be even more complicated and it will take years.
Most governments are very shortsighted and they are focusing on how the market views them today. This has led to extreme austerity measures that will eventually kill any growth potential. My plan of little austerity combined with the right type of spending will not be as popular amongst the masses. I am able to offer such a plan because I am not up for reelection in a few months/years. Politicians in Europe and the U.S. better wake up and realize what needs to be done to create growth today, and in the years ahead. If not, we will be revisiting the 2008 recession sooner than we would like.
Matt McCall discusses Austerity vs. Growth with Will Cain and the rest of the "Real News" panel on April 26:
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