A Tale of Two Countries

Austerity, Deficits, and Debt:  A Tale of Two Countries

by Elliott R. Morss, Morss Global Finance


Greece is involved in a series of austerity programs. And the US is considering austerity measures to keep it from “falling off the fiscal cliff”. The concern is even greater because nobody really knows what there is to fear. But it starts with the US government going bankrupt and burdening children so we can consume today. Below, I examine the pros and cons of austerity and deficit policies in Greece and the US.

Austerity/Deficit Analytics

When a government spends more than it takes in, it is increasing a country’s demand for goods and services – definitely good when a country is in a recession because it creates jobs. An austerity policy cuts back on that net aggregate demand stimulus and will cause jobs to be lost. The trick, coming out of a recession, is to phase in “austerity” (lower government deficits) when a country has reached a sustainable growth path without the government deficit stimulus.

Austerity in Greece

Austerity policies were launched too soon in Greece leading to the disaster Greece now faces. What happened is shown in Table 1. The government deficit was 15% in 2009. The IMF and Euro countries (led by Germany) forced Greece to reduce its deficit year-b-year to 7.5% in 2012. The result? GDP, already falling in 2009 started falling at a more rapid rate. Unemployment has grown rapidly: the IMF projects it at almost 24%. Others estimate that it is already over 25%!

Source: IMF WEO Data

Austerity proponents say it is necessary – nobody will lend money to Greece, and its debt burden is not sustainable. The IMF agrees that the something has to be done about the Greek debt but knows the austerity package it developed and implemented failed. It points out that Greek debt is not sustainable. From a news report:

“A source familiar with IMF thinking said the global lender was demanding immediate measures to cut Greece’s debt by 20 percentage points of GDP, with a commitment to do more to reduce the debt stock in a few years if Greece fulfills its programme.”

But the Euro countries, led by Germany, are now pushing more austerity and no debt relief. “Sleepwalking” is the best way to describe what is going in Europe right now. I quote from another recent news report:

“EU Economic and Monetary Affairs Olli Rehn said it was vital to disburse the next 31 billion euro tranche of aid ‘to end the uncertainty that is still hanging over Greece’. Negotiations have been stalled over how Greece’s debt, forecast to peak at almost 190 percent of gross domestic product next year, can be cut to a more sustainable 120 percent by 2020. German Finance Minister Wolfgang Schaeuble told reporters on arrival that a debt cut was legally impossible, not just in Germany but for other euro zone countries, if it was linked to a new guarantee of loans.”

Look at the last column in Table 1. More austerity? Reduce the government deficit further? What is the target unemployment rate? 30%? Keep in mind that Greece has no Euros left, so government deficits going forward must be financed by new borrowings.

As I have written, things will get worse in the Eurozone before they get better. More riots in the streets and political upheavals? All news sources are reporting that Greece’s anti-bailout SYRIZA party has a four-percent lead over the Conservatives who won election in June, adding to uncertainty over the future of reforms.

With this somewhat sobering view on Greece, let’s turn to the US situation.

Is This the Time for Austerity in the US?

I start with two quotes from a recent piece by Joseph Stiglitz. I agree with both.

  • “.…even with large deficits, economic growth in the US and Europe is anemic, and forecasts of private-sector growth suggest that in the absence of continued government support, there is risk of continued stagnation – of growth too weak to return unemployment to normal levels anytime soon.”
  • “The risks are asymmetric: if these forecasts are wrong, and there is a more robust recovery, then, of course, expenditures can be cut back and/or taxes increased. But if these forecasts are right, then a premature “exit” from deficit spending risks pushing the economy back into recession.”

Let’s look at the numbers. GDP is growing, but not in a way that instills great confidence. The deficit and unemployment are also falling. But again, not enough to suggest the US recovery is robust. Nearly all economists agree with this fragile recovery assessment.

Sources: US Bureau of Economic Analysis, US Bureau of Labor Statistics, US Treasury

In Table 3, deficit, GDP, and debt numbers are presented. It is important to realize that the 2012 deficit (stimulus) is 7.3% of GDP. That is significant. Another way to think of the significance of this deficit: if the US is growing at 2% annually. That is $326.8 billion. Eliminating even part of the $1.2 trillion deficit will wipe out this $326.8 billion in GDP growth.

Sources: US Bureau of Economic Analysis, US Treasury

Stiglitz’s caution that the risks of keeping the deficit or reducing it are asymmetric is warranted. If it turns out the recession is really over, the deficit stimulus can be ended. But if ending it puts the economy back in a recession….

Can We Grow Out of Debt?

The US and Greece are fundamentally different: Aside from bailouts, Greece can’t borrow: nobody will lend them any money. The US cost of borrowing is only 0.22% annually. Such a low rate raises the question as to whether the US could borrow enough to increase the GDP growth rate to the point that the debt/GDP ratio would fall. The current deficit of $1.2 trillion is causing debt to grow 7.3% annually. Just to keep the debt/GDP ratio from rising, GDP would have to increase by the same amount. I don’t see GDP increasing by that amount in the foreseeable future. Instead of reducing deficits now, we should wait until it is certain a solid recovery is underway.

Post Script

Stiglitz said one other thing that got me thinking:

“The financial sector has imposed huge externalities on the rest of society. America’s financial industry polluted the world with toxic mortgages, and, in line with the well established “polluter pays” principle, taxes should be imposed on it. Besides, well-designed taxes on the financial sector might help alleviate problems caused by excessive leverage and banks that are too big to fail. Taxes on speculative activity might encourage banks to focus greater attention on performing their key societal role of providing credit.”

All true. I have written extensively on bank reform, arguing that FDIC insurance should only be provided to banks that manage their own loans and don’t trade on their own accounts. I have recently concluded that the bank lobbies are too strong to get such a measure enecated. So I have a new suggestion. Consistent with what Stiglitz has said, how about levying a 20% transaction tax on all trades by banks whose deposits are guaranteed by the FDIC? Such a tax would cut way back on bank creation and trading of financial instruments. Banks that continued to trade would at least be compensating the government in advance for the next bank bailout.

Related Articles

Analysis and Opinion articles by Elliott Morss

Analysis and Opinion about the Eurozone

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