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Cutting to the stimulus chase

Karen Maley

Published 7:36 AM, 23 Jul 2010 Last update 10:13 AM, 23 Jul 2010


The time has come for developed countries to kick away their economic crutches and to start raising taxes and cutting spending, according to the head of the European Central Bank, Jean-Claude Trichet.

In an article written for the Financial Times, Trichet argues that policy-makers generally agree that yawning budget deficits should be reduced, but some argue that more stimulus is needed to avoid jeopardising the economic recovery, while others fret that simultaneous tightening will undermine the global recovery.

“I disagree with both these views. We have to avoid an asymmetry between bold, if justified, loosening and unduly hesitant retrenchment,” he writes.

With all the passion of a new religious convert, Trichet derides the previous economic panacea of boosting government spending to soften the economic downturn. “With the benefit of hindsight, we see how unfortunate was the oversimplified message of fiscal stimulus given to all industrial economies under the motto: “stimulate”, “activate”, “spend”! A large number fortunately had room for manoeuvre; others had little room; and some had no room at all and should have already started to consolidate.”

There is, he says, “little doubt that the need to implement a credible medium-term fiscal consolidation strategy is valid for all countries now.”

In the wake of the Greek debt crisis, many European countries have implemented austerity measures, such as increasing taxes, raising retirement ages, and freezing pensions. Trichet’s call for countries to bring their deficits under control comes amid signs that European economic activity is rebounding. The latest purchasing managers’ indices (PMI) indicate that manufacturing and services sectors in the eurozone grew much faster than expected in July. German manufacturers have benefitted from the sharp decline in the euro which has made their products much more competitive on world markets, while the French services sector is also performing strongly. Consumer confidence in the eurozone climbed to its highest level for two years in July, according to figures from the European Commission.

As well as tougher budget measures, there are signs that European authorities may be adopting a more hardline position when it comes to tonight’s release of the stress tests on 91 European banks. The French newspaper Le Monde reports that the banks will be required to reveal their exposures to sovereign debt, despite some last minute resistance from German banks over the amount of information they were being asked to reveal.

European authorities are hoping that the stress tests will demonstrate to investors that the vast majority of European banks are strong enough to withstand a renewed economic and financial crisis, and that the authorities are more than capable of resolving the problems of the weaker institutions.   

As part of the stress tests, Committee of European Banking Supervisors asked the 91 banks to provide information on their holdings of sovereign debt, although it has left the responsibility for publishing this information to the banks and national supervisors. According to Le Monde, German banks, which have heavy exposures to Greek debt, were the most reluctant to provide data, but they have now succumbed to general pressure to do so.   

The newspaper also pointed out that already politicians and bankers in several countries, including Germany, France, Belgium and Greece, have indicated that their financial institutions are likely to pass the test.

As part of the tests, the 91 banks have been submitted to tests to determine whether their core tier one capital remains above 6 per cent if the economy slumps, and if they suffer heavy losses on their holdings of sovereign debt. Institutions that fail the test will be required to disclose how they intend to fix their problems.

Earlier this week, the Slovenia’s largest bank, Nova Ljubljanska Banka – which had been expected to pass the stress tests - announced a capital raising, which suggests that even institutions that pass the test may be recapitalised.

According to Le Monde, the major listed European banks should all pass the stress tests. It suggests the main lesson from the review that the bulk of the problems lie with smaller regional financial institutions, such as the Spanish regional savings banks, or cajas, and the regional German landesbanks.

However, the German newspaper Frankfurter Allgemeine Zeitung reported overnight that all of Germany’s Landesbanks had passed the stress tests. 



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1 Comment


Don Gilbert wrote:

Should the stimulatory packages should have been highly targeted, as I've read on Business Spectator? (See Cutting to the stimulus chase, July 23).

Australia stimulated overseas exporting motor manufacturers as ours was so wide (not that our economy is large).

Well done, Canberra.

24 Jul 2010 7:21 AM



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