Austerity vs. Growth - Economic Crisis in Spain

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ETEA - Grado en Administaricón y dirección de empresas
Curso 2012-2013
Spanish and international economy

Austerity versus growth
Individual homework #1

The European economic crisis started in year 2010, the first visible serious problem was the debt crisis in the Greece and then other problems have showed. But the main fault had beginning in inconsistent European integration process. The EU has chosen halfway solution of economic integration - they have accepted just common monetary policy without the fiscal union. So from the very beginning of common European currency project instantly grew problems between integrated states, because unified monetary policy wasn’t convenient to everybody. Low interest rate (fixed by ECB) caused that some of the marginal economics have been growing too fast and on the opposite side developed economics have been growing really slowly. In the Spain low interest rate after year 2002 caused a boom in construction and Spanish economy became extremely dependent on this type of sector. The annual GDP growth was until year 2008 in interval 2-4%.

But the inflation rate was significantly higher than interest rates, so finally real interest rates were in negative values. Thanks to that in the Spain mortgages were cheap in that time and its demand of private sector was enormous. But Spanish banks didn’t have enough liquidity and had to use the external capital. Other inequality at market was showed when with growing price of real estate also grew its demand. However Spanish government discharged the fiscal criteria accepted by EU, they couldn’t control this irresponsible behaviour of private sector, because interest rates were held by ECB. So after collapse of the US mortgage market when ECB elevated interest rates, Spanish construction sector got into the trouble, real estate lost its prices and some people wasn’t able to pay back their mortgages. Construction and related sectors have a high share of national income in Spain, so crisis stroke there with bigger thrust.

If we look for achieved agreements in EU, we can see that in 1997 future Euro-zone states accepted the Stability and Growth Pact as some kind of substitute for common fiscal pact. Regardless of fines the Portugal has broken it in 2001, lately followed by the France and the Germany, so in 2005 monetary union states decided to make its repressive part weaker. Analogous end had so called “no bail-out clause”, which should protect fiscally responsible states from paying for irresponsible ones in monetary union. However, as we know, the Greece received financial help in May 2010. Right after Euro-zone states founded temporary rescue mechanism, one of his parts was EFSF. Proclamations said that it wasn’t design to usage, but during years 2010-2012 ESFS provided financial help to the Ireland, the Portugal, the Spain and the Cyprus. For year 2013 were planned start of permanent ESM, but finally it was in progress from July 2012 because doubt crisis intensified and both mechanisms worked at the same time.

So to run off the crisis Spanish government use the austerity policy. The main austerity points of 2013 budget are: * a 12% average cut in ministerial spending
* a freeze in public sector pay for the third consecutive year * a new independent authority to monitor government finances * an increase in pensions funded by drawing on 3bn euros of reserves * a new 20% tax on lottery wins above 2,500 euros

The Spanish government said that it was "a crisis budget designed to exit the crisis". They also mentioned their strong conviction that reducing of government's deficit would focus more on spending cuts than tax rises. Government believe that these cuts would reduce the deficit by 0.77% of GDP in 2013. Prime Minister Rajoy has promised cut total deficit to 6.3% in 2013 and under 3% by 2014 which should mean savings around 60 billion euros until 2014. The main reason of this policy is to convince investors that the...
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