9 February 2015

Petering out in Never Never land

Even if the EuroZone and the Greek economy survives the present crisis, there is a madness in its arrangements (fiscal compact) that threatens the Eurozone's long term existence. Crises will reappear whenever there is a peroid of strong growth in the Eurozone. Internal trade imbalances, surpluses and deficits will build up again and creditor countries and Euro institutions will again give the entirely wrong response. This, and the damage this cycle does to investment, makes Europe a lost Continent. It is ironic that Syriza, mistakenly called anti-Euro, has something that at least looks like a plan to save the Eurozone from itself. 

Remember that Fiscal Multiplier? 
see http://www.bloomberg.com/news/articles/2013-01-04/imf-officials-we-were-wrong-about-austerity

Here is a simple school exercise in numbers that seems to be beyond some European governments.

A country has a very large budget deficit and wants to reduce it. GDP is $100 and its budget deficit is 10% of GDP and it is told to reduce it to 5%.  So it cuts government spending by $5 and overall spending, GDP, falls by $5. 

Someone's spending is someone's income, and they too are forced to spend less which in turn affects other incomes. After a small cycle of after-effects (the multiplier) overall spending falls by, for example, by 1.5 times the initial cut.  If the tax rate is 25%, then the following changes are

    -$5 the initial spending reduction
    -($5)(1.5) = $7.5 the overall fall in incomes and spending - as people loss jobs and spend less

     Old tax revenues = $25 ;
     new tax revenues = $( 100 – 7.5) x 25% = $23.125
    -$1.875 = Fall in tax revenues 

The deficit falls from $10 to $6.875 (not to $5 as the Troika hoped for).

But what percentage is $6.875 of $95?   Hmmm its 7.4% not 5%. of GDP.  Someone's cheating, lets apply more cuts.  Surprise, surprise... those nasty Greeks are missing their deficit targets again.

The IMF assumed /calculated the Fiscal Multiplier was close to one, but it was found to be a lot higher in times of distress than in normal times. Europe's austerity policies were therefore founded on faulty assumptions. They should be reviewed. This is bascially what Syriza in Greece is asking for. It has to refuse to continue with a "bailout package" that is fundamentally wrong and destroying the real economy. For many Greeks the choice has become very simple: "your home or Grexit".

So why are some Governments so persistent, even if it means throwing away their own taxpayers' money? 

Well you need to believe in euro fairies as every time you don't believe in one, then one .... kind of exits.  Now you do believe in euro fairies, don't you .... ?

Never Never Land 2015

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