Economic and monetary policy

There are tough times ahead for Spain as the government announced €27bn of spending cuts in one of the most stringent austerity plans in the country’s history. Among other measures, civil sector wages and unemployment benefits will be frozen, and electricity and gas bills will rise. Spain is in dire straits financially, with a huge deficit, an economy that returned to recession this year, and an unemployment rate of almost 23% - the highest in the European Union. It is fervently hoped that this plan will pull Spain out of this financial mire and prevent it from requiring a bailout, as this could be utterly catastrophic for the Eurozone. Spain’s economy is the fifth biggest in Europe, twice the size of that of Portugal, Greece and Ireland put together, and many fear that if it goes into meltdown, it will take the Eurozone down with it.

The cuts sparked protests across the country, with demonstrations turning violent in some cities, and a general strike was held on 29th March. Yet some fear that these cuts, extreme as they are, will not be enough, and that the Spanish government will be forced to implement further austerity measures later in the year.

Image source: enric borràs on flickr

The EU and the IMF have agreed a second bailout of €130BN for struggling Greece. However, as German MPs voted in the Bundestag on 27th February to back the bailout, Angela Merkel admitted that there was no guarantee that it would it work and save Greece from bankruptcy.

In order to secure the deal, Greece has had to agree to a series of conditions, including reducing its debt from 160% of GDP to 120% by 2020. Certainly tough times lie ahead for the Greek people, who have already been demonstrating their unhappiness and anger. February saw the worst, most violent riots in Athens yet, as Greeks took to the streets to protest the austerity measures being passed in the Greek parliament. Greek unions have said the measures will “intensify the cycle of recession and drive Greek society to despair".

Some believe that the best solution would be for Greece to leave the Eurozone. Martin Hutchison of Money Morning believes that “to recover, Greece needs to leave the euro, devalue its new drachma by about two-thirds, and recover an export and tourism sector that would quickly re-employ its people, albeit at much lower living standards than they enjoyed in the fat years.” Nigel Farage, the Briitsh MEP and UK Independence Party leader, expressed similar views to these in his recent interview with The Euros. However, Merkel disagrees, claiming that to abandon Greece would be “irresponsible”.

Image source: Yashima on Flickr

This is the percentage by which Eurozone economies have contracted in the first three months of this year. Eurostat released the figure this week, which is higher than the 2% drop that analysts had predicted. German exports fell at a faster rate than imports, playing a significant role in the overall decline. In fact, the German economy dropped 3.8% in this first quarter of 2009, marking the biggest contraction to the German economy since reunification, almost two decades ago. Italy also fared quite poorly, it’s GDP dropping 2.4% - the greatest drop in the Italian economy in almost three decades. The French economy shrunk 1.2%, as predicted. Sharp declines are not unique to the Eurozone, however. In the wider EU, GDP also fell by 2.5%.

Image: www.flickr.com/ Boyan Yurukov

On Friday March 20, EU leaders met to establish a common strategy ahead next month’s G20 Summit in London. EU member states will collectively advocate for tighter global regulation of financial markets, and a stricter approach to tax havens. EU members of the G20 will ask their fellow members to guarantee ‘appropriate regulation and oversight of all financial markets, products and participants that may present a systemic risk, without exception and regardless of their country of domicile.’ The head of stated decided to double loans available to eastern Europe to 50 billion euro and to support the IMF with additional 75 billion euro.

Image: []European Commission Audiovisual Service->http://ec.europa.eu/avservices/down...

Who knows, maybe 2008 will be marked in History as a repetition of 1929. While at the outset, some expected the financial crisis to be a strictly American phenomenon, very rapidly it spread to Europe. Notorious banks such as Fortis, Dexia or the WestLB, to name just a few, had to be rescued by the state. During the European crisis summit in early October the heads of state of the Eurozone agreed to act together to resolve the crisis, and to help out the banking system with millions of euros. However, the resistance of the German government especially prevented the creation of a European safety fund. The European commission nevertheless promised an investment package of over 200 billion euros. The European Central Bank (ECB) that has so far proved very reluctant to take big steps, started became increasingly nervous. In early December it lowered the key interest rate in a historic step of 75 points to the level of 2,5 percent. The reason for this surprising action lies in the negative growth forecasts for the Eurozone. Instead of 0,6 to 0,8 percent growth, most of the member states are facing a recession. The year 2009 is going to be a tough economic year.

Photo: www.flickr.com; pnoid00

That is the new interest rate in the Euro Zone after the European Central Bank decided to raise the rate last week. This is the latest move of the ECB against the worrying inflation rate in the Euro Zone which was at 4% for the month of June. That’s more than twice the objective set by the central bank’s mandate. The move of the ECB was criticized by Peer Steinbruck, German finance minister and Spain’s Jose Luis Rodrigez Zapatero who fear that higher interest rates will accelerate the current economic downturn that the EU is currently undergoing. This is unlikely to influence the ECB whose president is always quick to remind politicians that the independence of the bank is the key to its credibility and efficiency.

They may think that the Euro led to price increases, but they are wrong. That is the message reflected in the quote above from a Commission press release following the publication of a report on successes and challenges of the monetary cooperation. The occasion is the ten years anniversary of the Euro, which became a reality at a European Council summit in May 1998. The new currency came to meet fierce opposition from many Europeans who experienced prices increases in the aftermath of the introduction of the actual Euro-coin in 2002. According to the report minor price increases did take place in the years following the introduction of the Euro and were brought upon the consumers by producers who raised prices marginally. Nevertheless, seen over the last ten years the report shows that the average rate of inflation has remained stable around 2%.

Danish Prime Minsiter Anders Fogh Rasmussen is currently negotiating with the opposition to prepare a September referendum aiming at scrapping Denmark’s EU treaty opt-outs on judicial and defence cooperation. On that occasion he also wants to announce that a referendum will also be held on the adoption of the euro. The Prime Minister has opted for a two step strategy hoping that he will easily win the first referendum creating political momentum for the second one. Rasmussen is widely believed to be in line for the job as EU Council president on behalf of the liberals, a couple of wins could really boost his chances.

Inflation in the Eurozone rose to 3,3% in March. Inflation in the 15-country region is now at the highest level since June 1992 when a 3,9 percentage inflation was registered. The high level is primarily said to be driven by extraordinarily high food and energy-prices. The European Central Bank expresses its concern on seeing so-called “second round effects” where the high prices on food and energy drive up prices on other consumption goods which in turn raises inflation. So in if you were hoping for a lower interest rate you are probably going to have to wait a while.

The leaders of the four G8 European States and the president of the European Commission met in London last week to call on all financial institutions to make a transparent assessment of the crisis they are undergoing in connection with the subprime fiasco in the United States. Merkel, Brown, Sarkozy, Prodi and Barroso appeared united in this PR exercise but this type of action leaves one wondering to which extent they have an influence on the situation. After all they can’t even decide on the interest rate in the eurozone and the calls of president Sarkozy for the CEO of Société Générale (the bank that triggered the current turbulence) to step down were completely ignored. It appears that financial markets have a logic of their own and that there is little politicians can do apart from polishing their own image.

Jean Claude Trichet, President of the European Central Bank, has reaffirmed that he would not cut the interest rate for the Eurozone in spite of fears of a slow down of the European economy due to the subprimes crisis in the United States. He believes that fighting inflation remains the priority of the European Central Bank while Ben Bernanke, the chairman of the US Federal Reserve lowered the interest rate by 0.75%, the biggest cut in 23 years. "We will see how the real economy develops in the future because it can have an effect on inflation” he declared in a speech to the members of European Parliament. This decision will certainly spark yet another debate on the mandate of the European Central Bank and the ability of the Member States to influence the European monetary policy. This issue is very divisive as Germany is very keen on maintaining the independence of the ECB and its role as an inflation watchdog while France believes the Member States should have more of a say in the decision-making process.

The battle for or against ‘Social Europe’ is increasingly taking up a central place in European politics. This week, the President of the European Central Bank, Jean-Claude Trichet, laid down another brick to the house when criticising recent wage raises in Germany and Finland. The chief of the ECB argued that wage raises harm the ECB’s attempts to bring down the rate of inflation, which in December 2007 reached 3,1%. The statements immediately saw trade unions retaliate that Mr. Trichet should “stop his fight against a more social Europe”. Whether one agrees with Mr. Trichet or not the very fact that the top dog of the ECB comments on such a highly salient political issue is bad news. Generally, European citizens are not used to hearing unelected bureaucrats from other countries commenting in negative ways on their wage raises. Granted, there might be several good economic reasons for the institutional design and the outspoken independence that permits the president of the ECB to comment on wage policy in EU member states. However the average citizens do not know or care about these reasons. From their perspective Mr. Trichet’s statements appear very strange. And very undemocratic.

This week, Jose Manuel Barroso travels to China for the yearly EU and China political pow-wow. Whereas human rights issues have traditionally been high on the agenda, another topic seems to be dominating the agenda of this year’s summit: the economy. European leaders are not satisfied with the trade balance between the economies of China and the EU. The EU is the largest oversee export market for the Chinese but the traffic seems to be only one way. The Union exports more to Switzerland than to China and the result is a trade deficit that grows by a staggering 15 million euros per hour. European leaders are accusing China for not opening its market and, more generally, not following the rules of the World Trade Organisation WTO. Whether Mr. Barroso will bring home results is another question. The Chinese leaders feel that they are struggling with economic problems at home. Consequently, economic reforms that would open the Chinese market are not considered especially timely.