The worrying logic in the eurozone

The logic of eurozone authorities has decoupled from the logic of financial markets, and as a result the implemented exit strategy from the crisis has been inefficient and dangerous, writes Patrick Artus, chief economist at Natixis.

Usually, financial markets in crisis require a slow adjustment plan combined with growth stimulation. When it comes to the eurozone, however, there has been a collapse in activity due to a European logic that does not match this requirement.

The determination to rapidly reduce fiscal deficits and improve competitiveness via a fall in wages, while prices are rigid, has led to this collapse. The stubbornness in this resolve has resulted in a worsening of fiscal deficits and a reduction in external deficits – mainly due to the decline in domestic demand.

Worryingly, recent decisions – including maintaining the schedule for fiscal deficit reduction in Greece, and further fiscal austerity measures in Spain and Italy – show that this strategy is being maintained, despite its inefficiency.

The exit strategy from the eurozone crisis, implemented in 2009, includes a rapid reduction in fiscal deficits and an improvement in competitiveness for the countries with problematic foreign trade (e.g. Ireland until 2008, Spain, Portugal, Greece and Italy, and France since 2005). These countries, European political leaders argue, allowed their wage costs to spin out of control since the creation of the euro.

But this strategy has shown itself to be inefficient and dangerous.

As these countries have each reduced their fiscal deficits simultaneously, the fiscal multiplier has proved to be very high, and there has been a far greater fall in real activity than expected.

The decline in activity has been amplified by the fact that, as prices are rigid (except in Ireland), the policies have led to a sharp fall in real wages.

The current situation is indeed very worrying: there has been a drastic rise in unemployment, making the talk of reducing fiscal deficits scarcely achievable.

The reduction in external deficits – in the cases where it has actually been reduced (in Spain, Portugal, Greece, and Ireland) – is not the result of an improvement in competitiveness and exports, which have been weakened, but is mainly due to the decline in domestic demand, and thus a reduction in imports.


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