This is a re-posted opinion piece.
Inside the Markets
REUTERS London – The odds on a new recession are shortening, but do not expect governments to swap the hair shirts of fiscal austerity for anything more comfortable.
Financial markets, worried as they are about anemic growth, simply will not let governments forget about deficits, even if the outcome is an even slower rate of expansion that risks driving ratios of debt to gross domestic product higher, prompting more anxiety that, in a vicious circle, further undermines growth.
“At the moment, the markets have priced in a very slow growth environment for the foreseeable future but have not yet priced in recession,” said Andrew Milligan, head of global strategy at Standard Life Investments in Edinburgh.
“They would welcome measures that even moderately raised that slow growth path for the next few years,” he added. “But markets would react very poorly if they thought governments were giving up the battle for fiscal control.”
On Friday, against that unforgiving market background, Spain followed the lead taken a week ago by Italy and approved additional spending cuts to help meet its deftcit-reduction target.
France, alarmed at the thought that it could go the way of the United States and lose its AAA credit rating, plans cuts of its own by the end of the month.
Britains public finances turned out better than expected in July, but the Treasury immediately said that the U.S. credit downgrade and continued turbulence in Europe made it vital for the government to stick with plans for cuts.
Even in Australia, with gross government debt equivalent to just 24 percent of gross domestic product, there is no political appetite for increasing deficit spending to counter the threat of a global downturn. Prime Minister Julia Gillard said last week that she was “absolutely determined” to return the budget to surplus by 2012-13.
Some analysts would like to see governments with fiscal policy space make more vigorous use of it.
“Why have politicians taken on board this whole idea that the answer is fiscal austerity at a time when unemploymentis a huge issue?” said Deepak Gop-inath, a director of Trusted Sources, an emerging markets research firm, who is based in Delhi. “Im puzzled by it.”
Economists at Morgan Stanley, who lowered their 2012 growth forecast for the euro zone this week to 0.5 percent from 1.2 percent, acknowledged that the sovereign debt crisis had not only ruled out pump-priming but could force governments to tighten fiscal policy further to meet their deficit targets.
As things stand, the fiscal changes planned this year and next by 20 major economies, which account for more than 70 percent of global G.D.P., are likely to reduce G.D.P. growth cumulatively by about 1.25 percentage points, according to a study by two International Monetary Fund economists.
So what can be done to cushion the blow to growth?
The government in Madrid sugared the pill of extra cuts by halving the sales tax on new-house purchases until the end of the year. It also said it would approve measures to generate jobs.
In the United States, President Barack Obama is exploring a package of pro-growth measures to be unveiled next month, while some investors expect a strong signal this week from the Federal Reserve chairman, Ben S. Bernanke, that the Fed will relax monetary policy again if the economy keeps deteriorating.
The problem is that the law of diminishing returns is kicking in. The Feds second round of asset purchases, introduced by Mr. Bernanke a year ago.worked like a dream for a while in pushing up share prices and confidence.
But it merely brought forward economic growth and could not ultimately stave off an economic relapse.
There is a growing realization that short-term palliat-ives are not the solution thats needed,” said Mr. Milligan of Standard Life Investments.
He said markets would welcome well-crafted strategies to increase the Wests flagging competitiveness and productivity. Deregulation, export incentives, apprenticeships for the unemployed, infrastructure investment and increased lending to smaller companies would all raise potential growth rates.
The problem is that such deep-seated changes that challenge vested interests are a tough nut to crack. It also takes years for such changes to translate into the stronger growth craved by governments and markets alike.
“Politicians and societies have not realized the nature of the crisis that we’re living through,” Mr. Milligan said. ” It is not one more push that will get us through. Debt deleveraging problems will be with us for years to come.”
Alan Wheatley is a Reuters correspondent
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By: Alan Wheatley
Source: Jakarta Post, Aug. 23, 2011
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