Balancing between Austerity and growth in EU…Rajesh Sharma Money Matters
Rajesh Sharma CMD Money Matters Financial Services Ltd. said in the medium and longer term minimum austere medium-term fiscal targets need to be offset by higher nominal growth. As we noticed that structural reform can ease external rebalancing so are reforms required to boost nominal growth.
Fiscal adjustment is key to almost all European region. Significant measures are required to establish fiscal sustainability over the medium term. However election results have shown a popular swing against austerity measures. In this context, the Euro area is reconsidering how to achieve a suitable balance between austerity and growth.
Austerity acts as a drag on growth in the short run and the pace of fiscal consolidation is so high that the benefit of further austerity (in terms of budget improvements) is small, or even negative. For economies who face this challenge a more efficient fiscal adjustment is necessary and then commitments to medium-term targets are secured. Spain is an example which can benefit from such measures.
The Euro area faces a large rebalancing challenge. It is evident that structural reforms could help to address the external rebalancing challenge. Suppose countries were to adopt structural reforms bringing them near median performance across the Euro area, the real exchange rate depreciation adjustment would be reduced notably.
For 2012, the Commission forecasts Spain’s deficit at 6.4% of GDP but much larger than Spain’s official target of 5.3%. In 2013, France is also expected to miss its target. The divergence in both cases is due to differences in policy assumptions. Spain will slip from its 5.3% of GDP target. Recent comments from the Commission it is obvious that the economy is contracting sharply. Rather, the focus has shifted to monitoring structural fiscal issues, such as getting regional overspending under control. In the medium-term, Spain targets a primary fiscal balance of 2% of GDP by 2015. Italy has a more ambitious target, just below 6%, while the French and the German targets are for about 3%.
Can the balance between austerity and growth be improved….
If we control the speed we can have an efficient mix of austerity and growth in the short run but for medium term we should aim at institutional reforms. In the longer term we have to look at the trade-off between the degree of the government surpluses and nominal growth. There could be reforms which would boost nominal growth particularly those that both boost real GDP and lower the real exchange rate depreciation. For the deficit countries, one such reform is to increase the relative size of the tradable sector. This, in turn, would also work to raise GDP as it would increases in productivity in the tradable sector. An attempt to increase the size by switching resources from the non-tradable sector to the tradable sector via reducing the size of the government works as well to improve the trade-off by increasing the fiscal balance (assuming taxes are left unchanged). Another way to improve the trade off is by lowering the political cost like the labour market reforms that boost output.
Research suggests that the challenge of achieving external and fiscal balance is very large in the Euro area. But there is a ray of hope where targeted reforms can significantly reduce the real exchange rate appreciation requirement and the need for deflation. The target for the medium-term balance needs to improve, particularly in Spain, countries like Italy and Spain seem reasonably well placed to benefit from such reforms. Credibility of government solvency is a necessity in all the austerity measures for both the short and medium term, the balance between austerity and growth. “Austerity & Growth Should go hand in hand without compromising either”-says Rajesh Sharma CMD Money Matters Financial Services Ltd.
Disclaimer: I, Rajesh Sharma, hereby certify that the views expressed reflect my personal views about the subject. The information contained herein is from publicly available data or other sources believed to be reliable, but we do not represent that it is accurate or complete and it should not be relied on as such. This document is provided for assistance only and is not intended to be and must not alone be taken as the basis for any investment decision.
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