05 September 2011

FT: Why austerity is only cure for the eurozone

Wolfgang Schäuble argues that excessive state spending has led to unsustainable levels of debt and deficits that now threaten our economic welfare. He writes that governments need not just to commit to fiscal consolidation and improved competitiveness – they need to start delivering on these now.

Schäuble, Germany’s federal minister of finance, writes that the recent developments have prompted a cacophony of prescriptions about what western governments should do next. There have been calls on regulators to rein in speculators, on the central banks to loosen monetary policy further, on the US and Germany to use their supposed “fiscal space” to encourage demand, and on EU leaders to take an immediate leap into a fiscal union and joint liability. Now more than ever is a time for clear messages and clear priorities.

There is some concern that fiscal consolidation, a smaller public sector and more flexible labour markets could undermine demand in these countries in the short term. Schäuble says he is not convinced that this is a foregone conclusion, but even if it were, there is a trade-off between short-term pain and long-term gain. An increase in consumer and investor confidence and a shortening of unemployment lines will in the medium term cancel out any short-term dip in consumption.

When markets become the bearer of bad news, there is a natural tendency to take aim at the messenger. The truth is that governments need the disciplining forces of markets. But markets, like the human beings they are made of, do not always act rationally. In uncertain times and absent a robust regulatory framework, their volatility can exacerbate a crisis.

One central lesson of the financial crisis was that markets could only function properly if risk-taking were not divorced from liability. The loosening of this bond was a central factor of the crisis. Likewise, the eurozone crisis unfolded after a decade during which economies with markedly different and, indeed, diverging fiscal profiles and competitiveness were all able to borrow at close to benchmark rates.

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