"Europe caught between austerity and growth : Which way out of

the crisis?"

Dr. Kurt HuebnerJean Monnet Chair for European Integration and Global

Political Economy, University of British Columbiawww.ies.ubc.ca

Debt, Debt, Debt

• ..is there an end?

…and more to come

• …Private debts

‘Swabian Housewife ‘ Approach

Expansionary Fiscal Consolidation Hypothesis

• Reducing public debt by either expenditure cuts or increases in tax receipts, or a combination of both, is key for economic recovery

• Lowering public debt softens any ‘crowding out effect’ and returns ‘trust’ into financial markets

• Reducing public sector employment and public sector wages/entitlements

Does it Work?

• Short-term high social and economic costs• Austerity and financial instability lead to

recessions• …not only in the Eurozone

Lessons from the Past

• Empirical case studies of previous exercises in internal devaluation show that austerity only ‘worked’ in combination with strong exports

• Not all can follow a ‘beggar-thy-neighbor’-policy

• Paradox of thrift dominates• Keeping troubled economies in ‘bad equilibria’

Banking crises and not so much public debt crises

Private debt overhang crucialDe-leveraging of private sectors (households;

non-financial corporations, and financial corporations)

Cleaning-up of balance sheets a difficult and cumbersome process that tempers economic growth

Shrinking growth or even GDP then leads to a debt trap

Interplay risk and growth

• dt = pbt + (it-gt)/(1+gt)dt-1,• with Δd change in general public debt, pb

denominating primary budget, i the effective interest rate (including risk premium) on public debt and g the rate of nominal GDP (t is the time factor)

• the higher the yield above the growth of GDP, the higher must be a primary budget surplus in order to keep the debt constant

Interplay risk and growth

• dt = pbt + (it-gt)/(1+gt)dt-1,• with Δd change in general public debt, pb

denominating primary budget, i the effective interest rate (including risk premium) on public debt and g the rate of nominal GDP (t is the time factor)

• the higher the yield above the growth of GDP, the higher must be a primary budget surplus in order to keep the debt constant

Implications

• Bringing down yield via orderly defaults, haircuts, bond-buy back actions…

• Using fiscal space by some economies• Stretching adjustment without risking moral

hazard• Redemption fund or other forms of

‘eurobonds’