Why have ‘austerity’ failed in the PIGS countries and succeed in Iceland?

Recently both the Italian and the Spanish governments have come out and said that they will have to revise their expectations for their budget deficits in negative direction.

Similarly, there has been renewed budget concerns in Portugal and Greece. Hence, last week IMF chief Christine Lagarde expressed strong reservations about Greece’s ability to achievement its fiscal targets.

So far the markets have reacted fairly calmly to rising concerns about the fiscal situation in particularly Southern Europe, but these concerns nonetheless raises the question whether or not we will see renewed euro zone financial turmoil again soon.

Some are eager to claim that the failure to consolidate public finances in Southern Europe is a lack of effort to do so.

However, the fact is that we have seen significant fiscal tightening in countries like Greece and Spain as illustrated by the graph below (the source is IMF and own calculations for all graphs in this post).

Fiscal tightening PIGS Iceland

What the graph is showing is the accumulative tightening of fiscal policy measured as the sum of yearly changes in structural budget deficit in the PIGS countries (Portugal, Italy, Greece and Spain) as well as Iceland. We use Iceland as an example of austerity in a non-euro country.

The graph clearly shows that particularly Greece has tightening fiscal policy dramatically since 2009-10 and now has tightened fiscal policy by nearly 20% of GDP. We have also seen a dramatic tightening of fiscal policy ins Portugal and Spain (and Iceland), but less so in Italy.

But how about the outcome? Lets look at the development in public debt.

Public debt PIGS Iceland

The outcome surely is depressing. Despite tightening fiscal policy by nearly 20% of GDP since 2009/10 public debt in Greece today is nearly 40%-point higher as share of GDP than at the start of the ‘austerity period’. And it is the same sad story for Portugal, Spain and Italy.

However, if we look at Iceland the story is completely different. Here public debt is nearly 40%-point of GDP lower today than when austerity was initiated in 2010.

So why did Iceland succeed with fiscal austerity while the PIGS have failed? Well, my loyale readers already know the answer – nominal GDP growth. Just take a look at the graph below.


Greece have been a depression style contraction in nominal GDP and NGDP is today nearly 30% lower than at the start of the crisis in 2008 and for the rest of the PIGS-countries we are essentially at the same nominal GDP level as eight years ago!

But then look at Iceland’s nominal GDP. Despite a total collapse of the Icelandic banking sector in 2008 and a sharp contraction in real GDP in 2008-10 nominal GDP grew through the crisis years (2008-10) and has grown robustly since then. Some – including me – would even argue that NGDP growth in Iceland has been growing too strongly.

So why this difference in NGDP growth between the PIGS and Iceland? Well it is simple – it is all about the monetary policy regime. The PIGS countries are of course euro members and have not seen enough monetary easing to get NGDP growth back to decent levels of 4-5%, which would be comparable to ECB’s 2% inflation target. On the other hand Iceland has seen significant monetary stimulus in the form of a sharp depreciation of the Icelandic króna and a drop in interest rates.

As a result monetary policy has more than offset the negative impact on aggregate demand from fiscal policy in Iceland and this is the real reason for the success of fiscal consolidation in Iceland.

This obviously has not been the case in the PIGS countries, where monetary policy has failed to offset the negative impact on demand from the fiscal austerity measures.

Without monetary easing fiscal woes will continue

This also leads me to the clear conclusion that we are very likely to see a continued increase on public debt-to-GDP ratios in the PIGS countries if the ECB fails to fundamentally and permanently lift NGDP growth in the euro zone to at least 4-5%.

Until that happens the PIGS countries have no other option that to continue to the fiscal austerity measures, but it is very unlikely to succeed for long unless we see a pick up in growth.

Therefore, policy makers in the PIGS countries should rather focus on growth enhancing policies such as cuts in corporate taxation and labour market deregulation and maybe also more immigration rather than on focusing on fiscal austerity. But the most important thing will be for the ECB to end the deflationary pressures in the euro zone economy. A 4% NGDP target accompanied by significant open-ended quantitative easing would do the job.

Unfortunately I have little hope for either reforms in the PIGS countries or a fundamental monetary policy regime change so I continue to think that we could very easily see an other of ‘euro turmoil’ in the coming months.


The Panama papers are all about the ‘Resource Curse’

Today’s Spain’s Minister of Industry, Energy and Tourism José Manuel Soria has stepped down “after his conflicting explanations inflamed a scandal over links to an offshore company listed in the Panama leaks.” (quoted from Bloomberg)

Note something interesting about this – a lot of the politicians/policy makers involved in the Panama leaks are in someway related to the energy and commodity sectors and I am pretty sure that if you ranked the countries most tainted by this it would all be commodity exporting countries.

Take for example these names – who all are on the list of names in the Panama Papers:

Angola: José Maria Botelho de Vasconcelos, Minister of Petroleum

Venezuela: Jesús Villanueva, former Director of PDVSA (the State owned oil and gas company)

Algeria: Abdeslam Bouchouareb, Minister of Industry and Mines

…and of course Soria who was among other things was minister of….ENERGY.

This to a very large extent illustrates the problem of corruption and cronyism that is often related to rent-seeking in commodity producing countries.

Said in another way the Panama leaks are to a very large extent an illustration of the so-called Resource Curse and unlike what most of the European media have been focusing on about “tax shelters”.

Are we about to get a new ”euro spasm”?


I hate to say it, but I fear that we are in for a new round of euro zone troubles.

My key concern is that monetary conditions in the euro zone remains far to tight, which among other things is reflected in the continued very low level of inflation expectations in the euro zone. Hence, it is clear that the markets do not expect the ECB to deliver 2% inflation any time soon. As a consequence, nominal GDP growth also remains very weak across the euro zone.

And with weak nominal GDP growth public finance concerns are again returning to the euro zone. This is from Reuters:

Spain plans to ask the European Commission for an extra year to meet its public deficit targets, El Pais reported on Sunday, after missing the mark with its 2015 deficit and raising the prospect of further spending cuts to narrow the budget gap.

The country last month reported a 2015 deficit of 5 percent of economic output, one of the largest in Europe and above the EU-agreed target of 4.2 percent. To reduce that to the 2016 target of 2.8 percent of gross domestic product (GDP), the Spanish government will need to find about 23 billion euros ($25 billion) through tax increases or spending cuts.

The economy ministry declined to comment on the newspaper report, which cited government sources as saying that acting Economy Minister Luis de Guindos would include revised economic projections in the stability program to be presented to Parliament on April 19.

And Spain is not the only euro zone country with renewed budget concerns. Hence, on Friday Italy’s government cut it growth forecast for 2017 and increased it deficit forecast. Portugal is facing a similar problem – and things surely do not look well in Greece either.

So soon public finances problem with be back on the agenda for the European markets, but it is important to realize that this to a very large extent is a result of overly tighten monetary conditions. As I have said over and over again – Europe’s “debt” crisis is really a nominal GDP crisis. With no nominal GDP growth there is no public revenue growth and public debt ratios will continue to increase.


So why are we not seeing any NGDP growth in the euro zone?

Overall I see four reasons:

  1. Global monetary conditions are tightening on the back of tightening of monetary conditions from the Fed and the PBoC.
  2. Regulatory overkill in the European banking sector – particularly the implementation of the Liquidity Coverage Ratio (LCR), which since mid-2014 has caused a sharp drop in the euro zone money multiplier, which effectively is a major tightening of monetary conditions in the euro zone.
  3. Continued fiscal austerity measures to meet EU demand is also adding to the negative aggregate demand pressure.
  4. And finally, the three factor above would not be important had the ECB been credibly committed to its 2% inflation target. However, has increasingly become clear that the ECB is very, very reluctant in implemented the needed massive quantitative easing warranted to offset the three negative factors described above (tighter global monetary conditions, regulatory overkill and fiscal austerity). Instead the ECB continues to fool around with odd credit policies and negative interest rates.

Therefore, urgent action seems needed to avoid a new “euro spasm” in the near-future and I would focus on two factors:

  1. Suspend the implementation across of the new Liquidity Coverage Ratio until we have seen at least 24 months of consecutive 4% nominal GDP growth in the euro zone. Presently the implementation of the LCR is killing the European money market, which eventually will be draining the overall European economy for liquidity.
  2. The ECB needs a firm commitment to increasing nominal GDP growth and to bring inflation expectations back to at least 2% on all relevant time horizons. Furthermore, the ECB need to strongly signal that the central bank will increase the euro zone money base to fully offset any negative impact on overall broad money growth from the massive tightening of banking regulation in Europe.

So will we get that? Very likely not and the signs that we are moving toward renewed euro troubles are increasing. A good example is the re-escalation of currency inflows in to the Danish krone. Hence, the krone, which is pegged to the euro, has been under increasing appreciation pressures in recent weeks and Danish bond yields have as a consequence come down significantly.

This at least partly is a reflection of “safe haven” flows and fears regarding the future of the euro zone. These concerns are probably further exacerbated by Brexit concerns.

Finally, there has been signs of renewed banking distress in Europe with particularly concerns over Deutsche Bank increasing.

So be careful out there – soon with my might be in for euro troubles again.

Iceland’s political meltdown

I must said when I see the events that are presently unfolding in Iceland I am very much reminded of that week in October 2008 when the entire Icelandic banking sector basically collapsed.
What we are seeing now is not necessarily an economic shock – I actually don’t think so – but it seems like a total collapse of the established political party structure in Iceland.
Things are changing minute by minute and the whole thing is quite surreal. I am not going to make any predictions about how this will end but Prime Minister Sigmundur Gunnlaugsson will soon by former Prime Minister.
It is only a matter of time before we have early elections and the big winner undoubtedly will be the Pirate Party. The only question will just how much support PP will get.
I still don’t think that PP will get a majority on it is own, but given the party was polling 35-36% in the opinion polls last week we could soon see support above 40%.
Iceland had a financial meltdown in 2008. Today it is a political meltdown. Will it also be a political revolution?
Update: The Icelandic PM has now stepped down.

This is how pathetic Danish growth has been

Take a look at the graph below. It is the level of real GDP in Denmark during the 1930s and over the past decade.

Real GDP Denmark 1930s and now

There is no way around it – over the past decade – from 2006 until 2016 – growth has been pathetic in Denmark. It has been a decade to total stagnation in the Danish economy.

Compare that to the Great Depression years. Growth was buoyant in the late 1920s and in fact the shock in 1929 did not have a big impact on Danish growth. However, GDP dropped in 1932 when the Great Depression really came to Europe a result of the Austro-German banking crisis, but from 1933 Danish growth once again rebounded.

So what is the difference between now and then? Well, a very clear difference is the monetary reaction to the crisis then and now.

In 2008 the Danish central bank hiked interest rates and intervened in the currency markets to maintain the peg of the Danish krone to the euro and in 2011 imported ECB’s catastrophic interest rate hikes.

During the Great Depression the Danish central bank on the other hand twice devalued the krone. First in 1931 when Denmark effectively floated the krone in 1931 and followed the UK’s decision to give up the Gold Standard and then later again in 1933 as apart of the so-called Kanslergade Agreement devalued the krone against the British pound. These two rounds of monetary easing effectively saved Denmark from the Great Depression.

Unfortunately we have not seen the same kind of monetary easing over the past decade and as a result the economic performance has been extremely weak.

However, it is not all monetary policy. In fact there is very good reason to believe that Denmark is also struggling with major structural challenges – particularly a very large public sector and the highest taxes in the world.

So if Danish policy makers fundamentally wanted to address the growth crisis then the response should be a combination of a change in the monetary policy regime – a floating exchange rates as Sweden, Norway and Iceland – and a substantial reduction in the size of the public sector. However, I might as well dream on – it is never going to happen.




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