The latest showdown in Washington raises a whole host of questions and conjectures about what will come after the agreement struck yesterday by the U.S. Senate. A closer look at the most crucial issues involved is therefore in order.
From Political Farce to Economic Instability
Viewing the federal government shutdown of the past two weeks as political farce may help mitigate the gnawing anxiety over how large a threat it represented to the world economy. In fact, however, this most recent tug-of-war has thrown a new quandary into bold relief: the economy is increasingly at the mercy of politics at its very worst. In other words, our economic future may be shaped by partisan wrangling, even of the most ludicrous variety. This is not just an umpteenth American specialty, either. It is a tendency inherent in the lingering crisis that has bedeviled the advanced economies for over five years now, and it introduces a new kind of risk—unpredictable, uncontrollable risk with the potential to wreak havoc. While the too-big-to-fail syndrome may still look like it can shield us from the disaster scenario—federal government default—we would be well-advised to brace ourselves in this new phase for serial drama over the issue of U.S. sovereign debt and fiscal policy.
Plenty of room for more political strife.
How much fiscal tightening in 2014?
When will the downgrade occur?
What rates? What policy from the Fed?
What does it all mean for growth?
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In pursuit of an Alternative Path
The French economy is undeniably in a bad way. But trying to overcome its shortcomings with the kind of shock therapy inflicted on Southern Europe would be the most dangerous response, both for France and the entire euro area. An alternative approach is therefore required—one that will necessarily involve leveraging more effectively the factors that set the French economy apart. This, then, is the value of taking a closer look at France’s key strengths.
France is in a bad way, with a very real risk of lapsing into critical condition
- You can’t cure debt with austerity
- Competitive deflation—a non-option
- France, Germany: two economies, two models
In pursuit of an alternative path
- Just what are France’s key strengths?
- The benefits of favorable demographics for demand, investment, available capital and personal wealth
- France’s underrated productivity
- French companies’ international footprint and standing
- Geographic location, tourism, and agriculture
- Leveraging the French economy’s strengths more effectively to tackle the crisis
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Europe’s most distressed countries should see their debt peak in a year or two, before descending to more manageable levels by 2020. Or at least that’s what the IMF, the European Commission, and the credit rating agencies all claim. Coming on the heels of the 2012 crisis, this is a heartening forecast—but a pretty surprising one, too. Just what is it based on? We’ve examined these institutions’ various scenarios for Italy and Spain, whose mounting sovereign debt burden loomed large in 2012, and for France, where the sovereign debt outlook raises a whole host of questions. Our assessment is as follows:
- All these projections are marred by overly-optimistic assumptions about these countries’ structural growth outlook and their ability to sustain highly restrictive fiscal policies. This makes subsequent revisions to the projections a foregone conclusion.
- Italy is a case in point: the projected growth rate is so fanciful that the country stands virtually no chance of deleveraging as hoped. More conservative forecasts would preclude the prospect of Italy stabilizing its debt in the next few years. They would show rather that by 2020, its debt-to-GDP ratio should verge on 140 percent.
- Spain seems to be in a better position to achieve such stabilization in the near term. Not only is its debt-to-GDP ratio 30 percentage points lower than Italy’s, but its potential output is apparently on the way up. Italy’s isn’t.
- Despite recent setbacks, France still seems to have the means to reverse its debt trajectory. If we assume average real GDP growth of 1.2 percent a year between 2013 and 2020, the country should be able as of 2015 to reduce its debt level just by maintaining a primary budget surplus.
What emerges from this analysis is that Italy is the exception—and unquestionably the most vulnerable of the large eurozone economies. This suggests that we’re in for further bad news once today’s widespread projections come up for revision. Which they probably will after the Italian elections, especially if—as is likely—the new government lacks the leeway needed to convince investors that it can and will do something about the country’s huge debt overhang.
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After several weeks of major uncertainty, investors hailed the ECB’s promises of late July, and the month of August provided a welcome lull. The two key questions are how long it will be before they start demanding follow-through on those promises, and just what the much-awaited measures will entail. By requiring Spain and Italy to request assistance from the EFSF rescue facility before agreeing to purchases of their government debt, the European leaders will only drive the EU even further into the morass it has been mired in for more than two years. And a growing number of countries in the region will inevitably get dragged down in the process. Unfortunately, those leaders show little inclination to do otherwise.
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The current approach to managing the sovereign debt crisis is so absurd that it will wind up destroying the European Monetary Union—perhaps even faster than anyone dares to imagine today. With the economy in free-fall since mid-spring, pressing ahead with fiscal adjustment programs means exposing Europe’s crisis-ridden countries to major risks.
Spain’s creditors initially greeted the new austerity plan unveiled by the Rajoy administration with a sigh of relief. Immediately after the prime minister’s announcement, long-term interest rates fell by a substantial 20 bps to 6.60 percent. The pledges offered by the Spanish government in exchange for greater flexibility in meeting the deficit reduction targets set by Brussels seem to have convinced observers. What probably made the biggest impression were the promises to overhaul public administration, with the number of local government councilors to be cut by 30 percent, and at the same time to raise the value-added tax rate by three percentage points.
Yet there are serious grounds for concern about whether Spain can overcome the crisis in this way.