Suddenly, it’s all about growth. After months of debates over austerity measures and fiscal consolidation, EU leaders seem to have understood that economic growth is a necessary part of the solution. Negotiations on the fiscal compact are still ongoing, but “growth”, that magic word, is now thrown in here and there to appease increasingly queasy citizens. However, our leaders don’t seem to have a clue as to what these  measures for growth should look like. Nor do they seem entirely convinced of the allegedly perverse effects of further belt tightening. It doesn’t help that economists seem to be in disagreement as well. 

Daniel Gros, the director of the Center for European Policy Studies, argues that abandoning austerity now would be dangerous. For instance, slashing taxes as a way to spur economic growth and reduce budget deficits would be delusional: in the United States, tax cuts were regularly followed by higher deficits. Credible austerity plans, he says, may aggravate short run prospects but will ensure long term sustainability. On the other hand, Peter Bofinger, member of the German Council of Economic Experts, and Sony Kapoor, managing director at Re-Define, a think tank (and, admittedly, my current employer), insist that Europe can’t cut and grow: a growth compact is needed alongside the fiscal compact. Their recipe involves a mixture of public investments, cracking down on tax havens and evasion, increasing taxes on wealth and accelerating structural reforms as well as deepening the single market. Which way should the EU go? If economists can’t seem to agree, maybe some sense of direction can come from the much disparaged financial markets. If, ultimately, one of the main objectives is to appease panicky markets and lower bond yields on the most troubled euro-zone economies, it can be useful to analyze how markets reacted to recent measures.

Tito Boeri, an economist at Bocconi University, has looked at the spread between the Italian Btp and the Spanish Bonos. The comparison is pertinent, he explains, as it removes the effects of the ECB’s interventions supporting both countries and other common shocks such as the deterioration of Greece’s situation. His analysis shows that the spread had reached a peak towards the end of December. Once the Italian government approved the “Save Italy” decree, a serious austerity package, the spread barely budged. Only after Monti’s cabinet moved to adopt the “Grow Italy” decree, attempting to liberalize the country’s relatively corporatist economy, did the spread really begin to decrease significantly. Boeri concludes that this seems to indicate that the markets are more keen on seeing measures that can promote growth rather than further austerity. 

The markets have at time been irrational and their judgment can be questionable, but among quarreling economists and dithering politicians they alone seem to show the road forward. Someone please lead the way.

Picture Source: http://www.flickr.com/photos/suratlozowick/5038081878/sizes/l/in/photostream/