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Recent developments now offer evidence that this prediction is coming true.
Recent statements from key policymakers in the euro area indicate that the public debate on austerity is shifting.
Most euro area economies have made big dents in their structural deficits. Indeed, many have moved into a structural primary surplus, giving Brussels plenty of excuses for leniency.
Periphery current accounts have also moved into surplus, thereby reducing the risk of financing problems.
Several factors are going to make it easier for Europe’s policymakers to backtrack on obsessive austerity. For example, the link between austerity and poor economic performance is very clear. Also, financial markets support some austerity slippage: the election of anti-austerity forces in Italy, budget deficit slippage in Spain, and the Portuguese Constitutional court’s decision to strike down some austerity measures has had no adverse effect on the ongoing bond market rally.
Also, as highlighted in our previous research, ‘Abenomics’ offers a template for Europe. Japanese Prime Minister Abe pledged a fiscal stimulus equal to 2.3% of GDP to be launched in 2013, which did nothing to dent the rally in JGBs. Abe has illustrated the importance of accumulating political capital through monetary and fiscal stimulus measures, in order to pursue structural reform later in his term. The idea is to establish credibility by generating nominal growth, and then to push through unpopular and painful reforms.
Bottom Line: We expect that European policymakers will de-emphasise austerity so that they can re-emphasise structural reform.
This post was originally published by the BCA Research blog.