The Truth About Spanish Fiscal Policy

Here’s an important piece of background for the Eurocrisis from Kash Mansouri:

The “fiscal balance” is the government budget deficit or surplus. The “ca” or current account balance measures total flows of money into or out of the country. You can see here that Greece and Portugal were, indeed, running irresponsible fiscal policies during the pre-crisis years. During an economic expansion, you really shouldn’t be running budget deficits, though in practice many countries do. And yet if this was fundamentally a fiscal policy crisis, you’d expect Greece and Portugal to be joined by France and Italy in acute crisis with Germany as the scary fifth risk. What you see instead is that Greece and Portugal are joined by Spain and Ireland in acute crisis with Italy as the scary fifth risk. The countries that are in great shape are the countries that were running a current account surplus before the crisis, not the countries that were running government budget surpluses.

The difficult question here, from a “lessons learned” perspective, is what exactly should the Spanish and Irish governments have been doing about this. It’s easy to say that Portugal and Greece should have acted more like Spain and Ireland, but even Spain and Ireland are in trouble. To understand how tough a problem this is to deal with correctly, you need to understand what a current account deficit combined with a budget surplus looks like. To people who fundamentally dislike whatever government is in authority, it looks perhaps like an unsustainable bubble. Prime minister so-and-so says he’s delivered prosperity, but it’s all smoke and mirrors! But to prime minister so-and-so it looks like a tremendous vindication. Thanks to his policies, the basic potential of the Spanish/Irish people is finally being unleashed. Unemployment is low. Wages are rising. The large net financial inflows represent a global vote of confidence in his wise policies and the fundamental merits of the Spanish/Irish people. If some sourpuss economic advisors shows up in the office saying there’s a problem, people are going to ask what the solution is. Give a speech telling international investors that they’ve got it all wrong?

“Folks, my policies just aren’t that big of a deal and you and me both know my country’s workers just aren’t that productive—take your money elsewhere!”

It would be . . . interesting . . . to see a speech like that. And it’s not even clear it would work. What you’d really have to do is run a giant budget surplus. But this would be mighty weird. Growth is humming along, the government is paying its bills, the debt:GDP ratio is falling, the cost of servicing the outstanding debt is low and falling, and you send to parliament a bill for a gigantic tax hike. Not to finance new services. Not to resolve a debt crisis. But to build up a rainy day fund to guard against future crisis even as the existence of the rainy day fund will inspire further confidence in the investor community that your country is a sound investment. Alternatively, you need capital controls.