1) Government embarks on austerity, to try and maintain the confidence of the bond markets. We must preserve the AAA rating for our government’s debt, says the finance minister.
2) Austerity reduces demand, helping create flat or negative growth.
3) As a result, deficit targets keep being missed. Additional austerity is imposed, and growth declines again.
4) Country loses its AAA rating, and the credit rating agency gives concerns about poor growth as an important factor for the downgrade.
5) This confirms our fears, says the finance minister. We must redouble our efforts to reduce our debt.
I do not like using decisions by the credit rating agencies as an excuse to write posts, because when it comes to the major economies they have no particular expertise. (Typically markets show no reaction to the ‘news’ that a country like the Netherlands has been downgraded.) This useful post by Bas Jacobs (HT MT) argues that the S&P analysis for the Netherlands does not deserve any serious attention. On credit rating agencies generally, see Jonathan Portes. The media report what these agencies say because downgrades are convenient hooks to hang existing stories on, and it is a shame and a continuing source of puzzlement that officials and politicians bother with them.
So why am I writing this post? Because it seems important to record the progress of another country beside my own that is going down a depressingly predictable path. When I last wrote about the Netherlands, some positive growth was expected for 2014, but the OECD’s latest forecast shows GDP flat next year. These forecasts also have consumer price inflation below 2% in 2014 and below 1% in 2015. The output gap is currently over (negative) 4%, and is expected to reach -5.5% in 2015. Unemployment, which was only 4.3% in 2011, is expected to rise to 8.1% in 2015.
Like the UK, the Netherlands is a country with no problem selling its debt. It has no macroeconomic need to achieve an expected (by the OECD) underlying general government surplus by 2015. As Jacobs notes, there is no question of an unsustainable long run fiscal position. The only major lever the government has to do something about lack of growth and rising unemployment is fiscal policy, yet it is using this lever in completely the wrong (pro-cyclical) direction, making everything worse.
A crazy policy. Yet it is followed by both centre-left and centre-right parties, even though this means these parties are haemorrhaging support to those further left and right. It is a policy supported by the central bank, which was one of those voting against the recent cut in ECB interest rates. The CPB, the country’s fiscal council that used to be a voice of sanity on fiscal matters, appears silent on the issue. Everyone can blame the Eurozone’s Fiscal Compact of course, but among the political centre they do not.
Coen Teulings, the former head of the CPB, speculated about why politicians seem so attached to austerity, when it is so clearly doing their popularity such harm. They seem to be stuck in an equilibrium (the ‘austerity trap’) where they fear that if any of them broke free, by declaring austerity harmful, they would lose out because other parties in the centre would declare them irresponsible, or ‘not serious’ to use Paul Krugman’s language. Yet they would all be better off, in terms of not losing support to the further left or right, if they could simultaneously break free of the austerity trap. Within any single Eurozone country the ‘irresponsibility’ charge is reinforced by the Eurozone’s Fiscal Compact, which in turn keeps the Eurozone as a whole in the austerity trap.