Thursday, June 17, 2010

EU Need a New Strategy

Spain is facing a worsening crisis. Markets are becoming less willing to buy Spanish bonds. The interest rate spread on Spanish bonds rose to 2% more than their German equivalent.

Why is Spain facing concerns over liquidity when there national debt to GDP ratio (59% - 2009) is still quite respectable?

source: Spanish economy watch
Spain has the second highest rate of unemployment (20%) in the EU. After a prolonged boom, house prices are dropping sharply.
Spain is suffering from relative uncompetitiveness, reflected in a current account deficit which was approaching 10% of GDP.

Despite a very fragile recovery at the start of 2010, Spain is now facing the prospect of a double dip in GDP. And, the only policy Spain seems to be following at the moment is cutting Government spending.

The combination of deflationary fiscal policy, falling house prices, rising unemployment and an impotent monetary policy and exchange rate policy means Spain is heading for serious deflation.

It is this deflation and prospect of prolonged recession which makes the Spanish economy look increasingly fragile.

But, do the EU have any strategy apart from austerity packages? Has anyone told the EU, you can't avoid a recession and deflation by just cutting wages and government spending. Has the ECB ever heard of the great depression?

It feels like we are in a time warp, when classical economists responded to the great depression by cutting government spending and cutting wages. As George Soros recently stated
"That's the real danger of the present situation – that by imposing fiscal discipline at a time of insufficient demand and a weak banking system... you are actually... setting in motion a downward spiral," (1)

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