Monday 16 September 2019

Philip Hartley: 'European rejection of austerity may spark economic expansion'

French police attempt to quell disturbances during ‘Yellow Vest’ protests in Paris
French police attempt to quell disturbances during ‘Yellow Vest’ protests in Paris

Philip Hartley

With concerns growing around the scope of the ECB to deliver further meaningful monetary accommodation, to offset the effects of slowing global trade and investment, the baton must now pass to European governments to step in with fiscal support. This has been long acknowledged by the ECB itself, with ECB Deputy Governor Peter Praet recently stating that monetary policy cannot be the only game in town.

The aftermath of the global financial crisis, and subsequent European sovereign crisis, saw national governments across Europe engage fiscal austerity in an attempt to stabilise public finances and sovereign balance sheets. Whilst the effectiveness of procyclical policy tools such as austerity to address an economic slowdown is questionable at best, it has, in conjunction with the subsequent economic upswing, created scope for governments to now step in should they decide. Early signs are encouraging, with the draft Eurozone 2019 budgets seeing the largest fiscal boost in over a decade.

This sudden drive towards fiscal expansion has come from an unlikely source - an upsurge in populism from Rome to Paris. Populists, or more often the fear of populism, are increasingly setting the fiscal agenda across national governments. This has been visibly demonstrated recently by the sights of weekly protests on the streets of France, forcing a U-turn by the self-appointed leader of the European political establishment, Emmanuel Macron.

His policies of structural reform and fiscal rectitude were swiftly replaced by increased minimum wages and curbs to income and social security contributions, highlighting the risks to the establishment from not engaging with a disillusioned electorate after years of austerity. The European Elections next month will invariably see fears of further populist gains. Whether these are realised or not, 2019 may well prove the nadir of the austerity- driven policies favoured by the European establishment after the financial crisis.

Ironically, this loosening of the purse strings will be led not by perceived proliferates of Southern Europe, but rather that harbinger of fiscal rectitude, Germany. In Germany the election in December of Annegrat Kramp Karrenbauer to replace Angela Merkel as head of the Christian Democratic Union (CDU) - effectively anointing her as the next Chancellor - has expedited this shift from the austerity driven policies of the past.

Being acutely aware that it was the CDU's poor performance in key state election's across southern Germany last October that finally triggered Merkel's demise, Karrenbauer will have one eye firmly on the state elections across predominantly Eastern Germany this autumn, not coincidentally the stronghold of the populist far right Alternative für Deutschland (AfD) party. She has so far called for €20bn of tax cuts with the Soli, or solidarity tax imposed during the 1990's, ironically to help finance German unification with these same eastern states, firmly in her sights ahead of the autumn elections.

However it is France which best epitomised the impact populist movements can have on today's governmental spending policy, with Macron forced to hastily announce €10bn of tax cuts and increases in minimum wages in December to fend off Les Gilet Jaunes. This is likely to be followed over the next number of weeks by further significant tax cuts, a key demand from the yellow vests movement, when Macron announces the conclusions of his great national debate, which has taken place across France over the last three months in an attempt to "transform anger into solutions".

With both Germany and France now predisposed towards fiscal largesse this leaves the last bastion of fiscal discipline in Europe, the European Commission, in an interesting position. The Commission has long been the most ardent proponent of fiscal rectitude within the well-documented Troika, comprised of itself, the IMF and European Central Bank. It is this Troika who have determined the strict conditionality around the bailout packages provided to those sovereigns most severely impacted post the European financial crisis of 2011/12, particularly during the tenure of the previous German Finance Minister Wolfgang Schauble.

The seismic policy shift by the two largest European powers away from austerity, combined with the upcoming European parliamentary elections next month (from which the new EU commission will be drawn), will most likely see this last bulwark of austerity pivot towards a more accommodating stance. This will hardly go unnoticed by those Southern European countries, particularly Italy, whose populist coalition government is still bristling from its bruising autumn encounter with the Commission after its proposed increased spending plans for 2019 were flatly rejected.

The European Central Bank will be watching all these political machinations from the sidelines with keen interest. The Eurozone economy has faced increased headwinds of late with a slowing Chinese economy, tariffs on global trade and Brexit uncertainty weighing on investment. The one area of strength has been the consumer as employment and, more recently, wages finally recover post the financial crises of the last decade. The ECB has provided extraordinary support to European growth since 2012 when its president Mario Draghi uttered his famous "whatever it takes" speech in support of the Euro-area economy, however its toolkit is now looking increasingly sparse.

It's safe to say that the rise of populism provides many challenges to the European political establishment. However, more importantly for the European economy and indeed the ECB, this challenge may well lead to long-needed fiscal impulse and ignite a well overdue self-sustained economic expansion.


Philip Hartley, Head of Foreign Exchange & Emerging Markets, Bank of Ireland

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