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Three conclusions can be drawn from the authors' analysis:
1) Since the start of the debt crisis financial markets have provided wrong signals; led by fear and panic, they pushed the spreads to artificially high levels and forced cash-strapped nations into intense austerity that produced great suffering. They also gave these wrong signals to the European authorities, in particular the European Commission that went on a crusade trying to enforce more austerity.
Thus financial markets acquired great power in that they spread panic into the world of the European authorities that translated the market panic into enforcing excessive austerity. While the ECB finally acted in September 2012, it can also be argued that had it acted earlier much of the panic in the markets may not have occurred and the excessive austerity programmes may have been avoided.
2) Panic and fear are not good guides for economic policies. These sentiments have forced southern eurozone countries into quick and intense austerity that not only led to deep recessions, but also up to now, did not help to restore sustainability of public finances. On the contrary, the same austerity measures led to dramatic increases of the debt-to-GDP ratios in southern countries, thereby weakening their capacity to service their debts.
In order to avoid misunderstanding, the authors are not saying that southern European countries will not have to go through austerity so as to return to sustainable government finances. They will have to do so. What the authors are claiming is that the timing and the intensity of the austerity programmes have been dictated too much by market sentiments of fear and panic instead of being the outcome of rational decision-making processes.
3) Financial markets did not signal northern countries to stimulate their economies, thus introducing a deflationary bias that lead to the double-dip recession. The desirable budgetary stance for the eurozone as whole consists in the south pursuing austerity, albeit spread over a longer period of time, while the north engages in some fiscal stimulus so as to counter the deflationary forces originating from the south. The northern countries have the capacity to do so. Most of them have now stabilised their debt-to-GDP ratios. As a result, they can allow a budget deficit and still keep their ratio constant. Germany in particular could have a budget deficit of close to 3 per cent, which would keep its debt-to-GDP ratio constant. Given the size of Germany, this would allow for a significant stimulus for the eurozone as a whole.
The intense austerity programmes that have been dictated by financial markets create new risks for the eurozone. While the ECB 2012 decision to be a lender of last resort in the government bond markets eliminated the existential fears about the future of the eurozone, the new risks for the future of the eurozone now have shifted into the social and political sphere. As it becomes obvious that the austerity programmes produce unnecessary sufferings especially for the millions of people who have been thrown into unemployment and poverty, resistance against these programmes is likely to increase. A resistance that may lead millions of people to wish to be liberated from what they perceive to be shackles imposed by the euro.
Response from Bruegel/Wolff, 25/1/13 © Bruegel