Unless you’ve been living under a rock, you have likely heard about the European debt crisis. I don’t mean to come off as patronizing, but most Swatties are busy and thus lack the time to pay close attention to world news all the time. So, let me give you a brief rundown.
A sovereign debt crisis can occur when investors begin to think that a government has borrowed more than it can feasibly repay given the state of the country’s economy and the size of the government’s deficit — especially relative to its growth. This causes the returns on government bonds to rise, rise and rise until the cost of borrowing is so high that the government has to pay more just to keep borrowing, and ratings agencies repeatedly downgrade the debt. All of this exacerbates the panic on the part of private investors who would be buying the bonds.
In the case of Greece (and Ireland and Spain and Portugal), multiple bailouts by other members of the Euro zone and the International Monetary Fund (IMF) still have not been enough to stave off more downgrades.
The European sovereign debt crisis differs from previous debt crises because the countries involved use the Euro, which prevents an individual state suffering from the rising cost of financing state debt from using independent monetary policy to devalue. This is what previous sovereign debt crises have resulted in — Argentina’s crisis in the late 90s is a prime example.
The country allowed the peso to lose value by unpegging it from the US dollar and ended up defaulting on its debts to other sovereign states and lenders. If Greece wasn’t on the Euro, it could have devalued its currency (printed money) to pay back its debts, suffered some inflation and focused on making meaningful reforms, which would prevent such a situation in the future.
However, the inability to use monetary policy left Greece struggling to follow the advice of its lenders, advice that saw austerity as the only answer for countries in both good and ill economic health. Now, over a year later, Euro zone countries are still trying to keep the whole of the EU from falling into a recession, though as the Washington Post’s Wonkblog noted, the tenor of current bailout discussions tends towards preventing a long recession rather than a recession in general. This is bad news for the US economy because, in recent years, the US and European economies have tended to be highly correlated, as shown in a recent Citigroup report.
That push for austerity, though, is by far the scariest takeaway from the entirety of the European sovereign debt crisis. I thought we’d moved past the Washington Consensus at least a decade ago. But for countries whose fiscal health is, well, Greek, Keynes is somehow forgotten.
Well, John Maynard, you are missed. While the huge structural deficit in the case of Greece resulting from relatively low taxes with relatively high social spending is unsustainable, suddenly cutting all that government spending during a recession (and lower tax receipts and higher levels of safety net spending) and a debt crisis (where borrowing is harder to do) is purportedly a good idea. In reality, Greece does need to work on having a long-term balance in spending, but austerity is never the answer during a recession.
It’s basic liberal macroeconomics that cutting government spending when the economy is already struggling to get out of a recession is not going to suddenly spur growth, especially in the face of financing the rising cost of government debt. Even in Euro countries without debt problems, the idea of austerity is touted as a cure-all. This is particularly disturbing given that most of these countries have a large welfare state that cannot suddenly be abandoned without serious damage to their economies.
And with American policymakers weighing in on the discussions in Europe, I can’t help but worry that this movement towards austerity is going to make its way across the Atlantic in a very harmful way. Growth estimates for the third quarter of the fiscal year 2011 (which ended in September) were not met, and unless governments realize that they need to raise taxes to finance greater spending, this austerity lesson is going to turn the US back on the road to recession.
The #euromess is coming to America. In some ways, it’s already too late. I don’t put a whole lot of faith in Twitter as evidence of social trends; nonetheless, the very existence of a hashtag for the sovereign debt crisis belies an understanding among the American media and public that what happens in Europe doesn’t just stay in Europe.
Olivia is a junior. She can be reached at email@example.com.