THE BLOG
12/09/2013 01:54 pm ET Updated Feb 08, 2014

Austerity Is Not the Answer for the Eurozone

Mario Dragui announced a few weeks ago the lowest interest rates in the history of the Eurozone. Actually, what have been reduced are the interest rates of the "Main Financing Operations," those by which euro banks finance themselves through the ECB. Furthermore, Dragui proclaimed that the interest rates would remain at the same or lower levels during a long period of time.

The economic logic behind is direct: with lower interest rates, investment is stimulated, and with it, employment should rise. However, as we can see in the graphic below, ECB interest rates have been decreasing since 2008, which points out the failure of the monetary policy of the European Institution. The Eurozone economy is not responding to the ECB interest rates' electroshocks.

The so-called "austerity" measures" -- which are not so austere since billions in form bank rescues are flowing to financial sector -- have been implemented in the Eurozone for more than five years, depressing the economy and drawing a new political and economic scenario. The reality is that the "austerity," imposed by elites and governments, has led us to an untenable macroeconomic situation. Budgetary cuts, wage cuts and employment destruction have already generated deflation danger in Europe as it did in Japan some decades ago. In the graphic below we can see how the Eurozone has been experimenting during 2013 with a continuous and significant price reduction, as for the European Union (Eurostat).

One of the main ingredients for the European recession recipe is private debt generated during the boom and public debt generated as a consequence of the recession. Debt-led crisis is a concern with a long history in economic thought going back to Irvin Fisher. He argued that the Great Depression was generated by a vicious circle where the price fall increased the debt value, which in turn caused subsequent price falls. He labelled these situations as a "debt deflation." Minsky's work -- Minsky acknowledged with Tobin that Fisher had a great influence in his theories -- so fashionable when explaining current financial crisis, defended that the capitalist system was subjected to cyclical crisis. During the boom phase of the cycle, the overoptimistic sensation of investors makes them increase their debts, laying the foundations of a future crisis. Recently, Richard Koo brought into fashion the term "balance sheet recession" to designate a situation where agents are massively trying to deleverage simultaneously, which prevents expenditure, depressing further aggregate demand and generating recession. Taking into account the importance of the debt recession in economic thought -- heterodox economic thought -- we should witness economic models being built focusing on debt issues in relevant economic institutions (European Commission, ECB and IMF). Notwithstanding this, it does not play any role in those models because the conclusions arising from that framework are radically incompatible with what they so badly call "austerity."

The fact that the Eurozone is entering a deflation situation is paradigmatic, since it does not just imply price decreases, but a dangerous spiral implying continuous decreases of wages, financial assets and real estate prices. Larry Summers gave a speech at the IMF announcing that we were entering a prolonged period of stagnation, remembering what the economist Alvin Hansen called "Secular Stagnation." The hypothesis brought forward by Summers was that interest rates were too low for too long. However, debt is currently the most important dead weight for the European peripheries, as it was for so many years for Latin America. Public service destruction in Spain has no precedents, and the new political and economic configuration being put in place is not the result of a long period of low interest rates. It is due to the tenacious willpower to eliminate all the conquests made in the last century, which allowed us to ensure minimum living conditions. It is the result of the fact that those who are today preaching the excellences of privatizations have not known the time -- not so far away -- where in Spain, most people had to save for weeks if they wanted to go to the doctor. It is the result of a reconfiguration of the social, productive and political model, which makes us sink in a long period of stagnation and deteriorates our life conditions.