While
all the current focus is on the challenge to austerity thrown up by the French
and Greek elections, it may be salutary to look at an equally recent
challenge that failed. Towards the end of April the Dutch conservative coalition
government collapsed, when the far right party refused to discuss further
budget cuts. The Prime Minister resigned. And yet a few days later other
parties rallied round to give their support to a similar package of austerity measures,
which now have majority support
in parliament.
This
austerity was not required by the bond markets. The government can borrow
at very low interest rates: 2.3% on 10-year bonds. (Predictably a ratings
agency made noises about the country losing its triple AAA after the government
collapsed, although not the same one that infamously downgraded US debt last
year.) It is definitely not required by the state of the Dutch economy: GDP is expected
by the IMF to fall by 0.5% this year (that’s a -0.5% growth rate), with
unemployment rising from 4.5% to 5.5%. So what could have led a government to
try and cut spending and raise taxes at such a time to the extent that it
brings the government down? The answer
is the ‘Excessive Debt Deficit Procedure’ (EDF)
of the EU’s Stability and Growth Pact. The budget deficit as a percentage of
GDP was 4.7% in 2011, down from 5.6% in 2009. Without these measures it would probably
have stabilised at around 4.5% of GDP, and the objective of these additional
cuts is to bring it down to 3% by 2013.
This is worse than trying to balance the budget in a
recession – it is trying to reduce the budget deficit in a recession. (A small
caveat – part of the package is an increase in VAT, which if delayed and phased
could
stimulate demand in the short run.) Now these measures, like raising the retirement age, may be
perfectly sensible from a longer term perspective. But, VAT aside, they should not be
introduced in a recession. What is really depressing from a Eurozone
perspective is why the package appears to have been implemented now at such
great political cost. The timing is all about the EU’s deficit limits, and a
belief that Netherlands has to show the rest of Europe an example. The finance
minister said
the plan would send Europe “a signal of solid government finances”.
An irony here is that the Netherlands has a longstanding and
very well regarded fiscal
council in the form of the Central Planning Bureau (CPB). One of things the
CPB does is cost both government and opposition budget plans before an
election, something Simon Johnson has recently suggested
the CBO could do in the US. So the argument that austerity has to be implemented
now rather than later because institutions are weak is even flimsier in the
Netherlands than elsewhere.
Unfortunately, it appears the CPB has not managed to educate the majority of
politicians about the foolishness of pro-cyclical fiscal policy.
From a Eurozone perspective this is a disaster. The
Eurozone is cutting its cyclically adjusted deficit faster
than the US or even the UK and heading for a second recession, and possible
political disintegration. As I
and others
have discussed, with Germany there is at least an argument that with
unemployment falling there is no scope for any fiscal stimulus there. Yet
unemployment is rising in the Netherlands. There is no, and I repeat no, good
macroeconomic reason why a stimulus package should not be implemented here.
And yet we get exactly the opposite.
"This is an unbelievable achievement," the now
caretaker Prime Minister told MPs after clinching the new deal.
I can see that reducing budget deficits would further diminish an already depressed AD and therefore not be a smart idea.
ReplyDeleteIf the deficit was reduced but the money supply was simultaneously increased via a subsidy on all transactions in the economy until the desired level of economic activity was achieved could one not have both a balanced budget and a healthy economy ?
The CPB agrees with you and has advised the government not to cut the deficit further during the recession.
ReplyDeleteOn the other hand, the Netherlands' central bank president Klaas Knot has made the opposite argument, supporting the government (in fact saying that no matter what government comes to power, it MUST adhere to the Maastricht Treaty requirements, at any cost.
Knot argues that the country is teetering on the brink of a loss of confidence by financial markets.
He doesn't deny that pro-cyclical fiscal policy will lead to demand destruction, and worsen the recession but says it's worth it: if not undertaken, the government will suffer worse because of higher interest rates and other unspecified consequences of failure (presumably the role a Dutch failure to meet EDF could/would/might play in leading to Eurocalypse Now).
What do you make of that argument?
Thanks for this, which is interesting. Do you have sources for the CPB and Knot views? As far as I know there are no Dutch economics blogs in English, so I'm overdependent on the English speaking media.
DeleteOn the substance of Knot's argument, I would respond as follows. If the deficit stayed at 4.5% (or even rose) during a recession, would the markets seriously think the Dutch government was suddenly insolvent (with a lower level of debt than Germany)? The only circumstances I can imagine in which they might is if the state was forced to bail out a large Dutch bank - is that likely? However, the way to spook the markets is to enter a deflationary spiral where the political situation looks unstable, which is what seems to be happening. In other words, it looks as if the Netherlands is trying to put itself in the same position as Spain, Ireland etc.
Rightly says Klaas Knot: Cut back, right now!
DeleteBy Philip Ward
Bank President Klaas Knot warns: fast cuts are necessary
"We can not count on that with growth of trouble," warns Klaas Knot morning in The Guardian. "If there is fault, it will actually be reduced."
Whether his message still arrives on time at the last moment to influence the negotiations in the prime minister's residence is the question.
Try
But it's worth a try. The message of Knot is one of the true line of prudent central bank governor - modeled on the German tradition that that country is so successful: if the economic unlucky, and deficits from, you should not complain, just cut back.
Not tomorrow, but now.
Gamble
The economic growth that will come back as the finances of government and citizens are healthy. Gambling on economic growth to solve problems, is perilous.
Any attempt to stimulate the economy through economic aid and fewer cuts, as attempted in the United States: it does not alter the Netherlands.
Compensate
Even in the United States - a much more flexible economy with less government interference, a freer labor market and greater entrepreneurship - it's just how the little economic growth now being realized, once the alarmingly rapidly rising national debt will be able to compensate.
In the Netherlands, including its large civil service, the sky-high tax burden and the extremely expensive welfare state, any postponement of firm cutbacks testifies to a lack of realism. Or a desire for self impoverishment.
http://www.elsevier.nl/web/Opinie/Commentaren/336583/Terecht-zegt-Klaas-Knot-Bezuinigen-en-wel-nu.htm
Did the CPB say that? As far as I know, they said that this new budget compromise was not clear enough to be scored, because too many of the details were kind of blurry.
Delete> The only circumstances I can imagine in which
Delete> they might is if the state was forced to bail out
> a large Dutch bank - is that likely?
Not immediately, but there is the minor problem of the total Dutch mortgage debt overhang, which is currently about 600 bn Euros - so about the size of GDP, which is by far the largest percentage of GDP in the EU. If the EU wide economic implosion would gain traction and NL would end up in the line of fire as well, then ultimately the government will have to step in and bailout the largest Dutch banks, ING and Rabobank, since together with the already bailed out and state owned ABN-AMRO bank, they hold roughly 70% of all Dutch mortgage debt. (And yes, in that case ABN-AMRO would have to be 'bailed out' a second time...) As no one knows how deep this crisis will eventually go, and plenty of financial events previously considered impossible have come to happen anyway, it's undeniable that the Dutch government +could+ rapidly loose its current solid footing, under such dire circumstances. (Although likely much of the rest of the EU would be burning too by that time.)
Usually that 600 bn Dutch mortgage debt is considered to be countered by Dutch pensions savings, which at the end of 2011 were estimated just short of 900 bn Euro ( bit.ly/xHebKU ). So indeed, on a countrywide macro basis, there are enough Dutch reserves to include even a large part of the current government debt in the overall balance. However, those pensions savings are not government funds, but are held by independent pension funds, and of course owed to pensioners - not to banks or house owners. The government cannot not use that pool to bailout banks, or if it did so anyway it would make one heck of a reappearence of Robin Hood, robbing a significant -rich- part of the population in favour of another -poor- significant part. Not likely, and therefore the 600 bn Euros mortgage debt remains a "known unknown"...
As for your caveat, unfortunately the VAT raise is supposed to take effect in 2013, so you can scrap that.
ReplyDeleteAlso you did not mention that the Dutch government debt is at 65% in 2011, which is about the lowest in the Euro zone, so there's really no pressure building more government debt. Except of course from rules based on arbitrary numbers (3 and 60), especially because the Dutch were the ones that pushed these strict rules hardest in the first place.
And about the CPB, here they explain what they do and what others can learn from them. Note that it's important for them to be independent and therefore stay out of political discussions. This is probably why they are very careful in messaging their opposition to too much austerity now.
As for the political side, it is a pity that the labor party which did not take part in this deal just had a new leader who hit the ground running, so he's not very effective (yet) in explaining these points. On the other hand, the liberal free market party leading the government, and therefore responsible for getting us into this mess (they pushed hardest for this 3% deal), is inexplicably doing well in the polls. It goes without saying that the press (who mostly sneer at labor for not "taking responsibility" and praise the PM for cheering) is not doing its job, and I think this is more important than what the CPB is not doing. (Oh, BTW, I normally do not vote for labor, but this time I am strongly considering to.)
2013? I understood the VAT was to be raised by October.
DeleteSame here, I normally would vote for CDA or CU, but I am so disgusted by the last events that I am considering voting PvdA or even PS.
Good post. Slight caveat - EDF is Excessive Deficit Procedure. You've made the dreaded Debt/Deficit mistake/typo
ReplyDeleteKlaas Knot is a direct political appointment by our PM. The reason was that, during the negotitions predecing the formation of our now caretaker cabinet, the candidate that was tipped to succeed Mr. Welling as our central banker lost a discussion about the necessity of huge budgets cuts to the director of the CPB, Coen Teulings. So, the PM found another candidate, Klaas Knot. I would like to see that discusion repeated, now between Klaas Knot and Coen Teulings.
ReplyDeleteThe Netherlands has had one of the largest trade surplusses ever in the first quarter of 2012. This did not show up in any reduction in budget deficit (probabely as a result of both austerity measures and a hampering housing market which received a 1,2 Billion tax break while already generating 3 B less per yearin taxes).
ReplyDeleteThe problem with stimulus is that the openness of the Dutch economy make it hard to design stimulus in such a manner that make the effect of it fall largely inside of the Netherlands. If it does not, it is hard to sell politically.
Harrie Nak misses the point that the Dutch cuts are argued to be unneccesary in this blog.
DeleteFurthermore it seems very possible to me to devise stumuli that do not greatly leak away.
Harrie Nak is correct, a stimulus in the Netherlands would not be as effective as in the US. That is also the reason why Klaas Knot said: negative effects of the austerity will also leak out of the country. (Meaning: others will suffer because we have to reduce the deficit)
ReplyDeleteStimulus should be done on a large scale, EU wide. But "thinking big" is not something that politicians and bankers in the Netherlands seem capable to do.
I missed the point that the blog finally argues for a stimulus package, at least against the pro-cyclical policies that are supported by a majority of parliament and a majority of the population as well.
DeleteWe have to wait and see what will happen to those majorities.
very brief comment on some of the comments:
ReplyDeleteDutch monetary policy is tied to the ECB, so there can be no coordination of Dutch fiscal and monetary policy.
Fiscal policy in a small open economy: possible leakages are for the second round of spending (and third, etc.) , not for the first round, which the government conducts and can target on Dutch domestic stuff, rather than imported stuff. In the worst of cases, the multiplier would be 1. But a tax cut starts with the second round, as it were, and the worst case scenario is a multiplier of 0, where every dollar of tax cut is saved or spent on foreign goods. (short- to medium-run multipliers).
And lastly, a Dutch fiscal stimulus is likely to be MORE effective than in the U.S. Why? because the U.S. has a federal structure and each dollar of federal spending leads, essentially, to a dollar reduction of state spending! That's why the Obama stimulus did very little and why Krugman wanted so much more of it. In Holland a dollar spent will not lead to a scaling down at the provincial or city level.
Thanks Prof. W.-L. I enjoy your posts.
Why does “each dollar of federal spending lead, essentially, to a dollar reduction of state spending”?
DeleteI'm just a layperson with regards to economics, but everything I've read from Keynesians has seemed to come true, while the deficit hawks seem to lose the empirical battle. Nevertheless, as a Dutch person I hesitantly support these measures.
ReplyDeleteWhy? Well, for one thing we would have to pay a fine of €1.2 billion if we didn't comply. I have little faith that we could convince the EU to change their policy, since we're just a small country and we've been one of the strongest voices for austerity (unfortunately). Now that Hollande has been elected in France, I have slightly more hope that something will change.
Secondly, the measures themselves are actually quite good. The Netherlands have suffered from a consensus-driven political gridlock over a number of issues, including ridiculous subsidies on mortgages, inflexible labor laws and strong resistance against raising the retirement age. This agreement is the first step in a direction which will hopefully lead to a fairer balance between generations; many young people are feeling quite screwed over by the current situation, knowing that they themselves will never profit from some of the current policies. Furthermore, it also has a number of policy steps that will lead to a greener economy and it reverses some pretty brutal cuts in education and health.
As a person living in NL I disagree.
DeleteI know plenty of young people who feel "quite screwed over" who indeed support VVD and D66 etc. They happen to be young people who are among the lucky ones with good jobs, who got out of school that was already paid for by the government and are in the early stages of well paid careers with no thought to pension much less middle age.
I do not believe that you will find so many un/under-employed young people in NL who care at all about the intricacies of the policies and whether they will lead to sustainable long term budgets or a "fairer balance between generations". They care about if they have a job that pays the rent, and their numbers are growing. Policies like the ones in the new NL budget will lead to further economic stagnation and recession, which means continued suffering for young people, regardless of the ideals supposedly behind them of "fairness" and "reform".
I think what European policy makers from Finland to (recently at least) France are slow to realize is that they are radicalizing an entire generation of under-employed people with this absurd focus on austerity. Which, by the way, is not meant to "balance budgets" for its own sake but rather to protect the current wealthy and their interests. This is obvious when you consider that even now Spain will not raise the capital gains tax as part of their savage austerity.
"I think what European policy makers from Finland to (recently at least) France are slow to realize is that they are radicalizing an entire generation of under-employed people with this absurd focus on austerity."
DeleteIt's happening in the US too and the "policy makers" are just as blind. They are fools who are incapable of learning. They'll be thrown out by the people sooner or later.
As far as I'm concerned, the only issue, the *only* fight, is pointing this radicalized generation towards social democracy, rather than towards neo-Naziism, fascism, Maoism, or Stalinism, which are equally likely outcomes.
Also, there's the argument that serious political reforms, including necessary cuts, seem to possible only during times of crisis. It's unfortunate and goes completely against standard economic logic, but that's how it is. The Netherlands had a surplus during the 90s, but a lot (fortunately not all) was spent on new programs and tax breaks. Similarly, some needed reforms in the 80s (which some say have led to boom in the 90s), including severe cuts, were made during times of very high unemployment.
ReplyDeleteIt's just how it is, unfortunately.
Im not an studied economist but am very happy to read your analysis...I dont know what`s the right thing to do in Netherlands only I doubt if there is really a recession here, reading the facts you give there is only a little rise in unemployment from a very low level and a year with -0.5%GDP in a highly developed economy seems not worrying to me...I think general feeling in northern Europe (or here in Germany) is that we are not in a recession - at least not a normal one - like "everyone is working, problems coming only from financial sector and real recession only in spain"(e.g. I think private consumption has gone up in Germany?)
ReplyDeleteSlightly off topic, but relevant to the wider debate between different economic schools' approaches to austerity, is this piece in the FT by Jeffrey Sachs
ReplyDeletehttp://blogs.ft.com/the-a-list/2012/05/07/we-must-move-beyond-growth-
versus-austerity/?#axzz1uHJzzDRC
(you need to register with the FT to read, but it costs nothing.)
This comment has been removed by a blog administrator.
ReplyDeleteThis comment has been removed by a blog administrator.
ReplyDeleteNetherlands Economy
ReplyDeleteHere is the article on budget cuts CPB-director Coen Teulings co-authored: http://blogs.ft.com/the-a-list/2012/02/27/eurozone-countries-must-not-be-forced-to-meet-deficit-targets/#axzz25yHkHq16
ReplyDelete