Austerity in the time of recession

By Dave Anderson:

We are about to see the implications of austerity during a major recession as Greece and Spain are being forced by their Euro obligations to significantly reduce their budget deficits despite mass unemployment and the European problem of labor market immobility due to language barriers.  In the US localized unemployment converges to monetary bloc means by the migration of workers and their families from high unemployment regions to lower unemployment regions.  This is facilitated by a common language and a common (enough) set of laws that facilitate this movement.  The Euro-zone does not have the migration safety valve.  

Here is Business Week on Spain:

 Spain pledged to slash the budget deficit by almost three-quarters by 2013 to bring it into line with European Union rules and avoid the punishment investors have meted out to Greece.

The budget shortfall amounted to 11.4 percent of gross domestic product last year, Finance Minister Elena Salgado said today after a Cabinet meeting in Madrid. That will fall to 3 percent in 2013, in line with EU rules, with 50 billion euros ($69.5 billion) of cost savings. Separately, the government also plans to increase the retirement age to 67 from 65, she said....

The worst recession in six decades turned Spain�s 2007 budget surplus into the third-biggest euro-region deficit...

A jobless rate forecast to average 19 percent this year is swelling Spain�s deficit further. Unemployment will be 18.4 percent next year, falling to 15.5 percent in 2013, the Finance Ministry said today.

If we exclude the growth of a massive debt fueled housing bubble, Spain was relatively responsible in the first chunk of the decade, and then it got kicked in the nuts economically speaking. Unemployment and underemployment is massive, and the automatic stabilizers to prevent misery and deeper recessions are now getting slashed in order to maintain Spain's membership in the Euro-bloc.  

Greece is in even worse shape as the Wall Street Journal reports:

The pledge came as the government outlined the deficit-reduction goals for the next four years--the duration of the government's term--which include cutting the spending gap to 8.7% of GDP this year and 5.6% next year and below 3% by 2012.

"It is our commitment to leave behind the giant deficits of the past," Papandreou said in a government cabinet meeting. "We will do whatever we need to to achieve our targets."

Greece has been under intense scrutiny by the European Union, the markets and credit rating agencies since it revealed late last year that its budget deficit would hit 12.7% of gross domestic product, four times the EU's 3% limit.

Right now, Greek unemployment is projected to be over 20% by the end of the year.  

Austerity will be a good test of the value of deficits as I think Spain and Greece will see their unemployment and gap between actual and potential GDP increase.