Spain and other embattled European countries may be slashing government spending too quickly, the International Monetary Fund warned Tuesday, saying deep budget cuts could be choking off economic growth vital for curing their financial crises.
The findings were detailed in a new IMF study that raises basic questions about how Europe is responding to the debt crisis unsettling the continent’s markets and depressing its economies.
While concerns about Europe’s health eased in recent months after political and economic leaders took new steps to contain the problems, anxiety has been on the rise again lately.
The cost Spain faces for borrowing money has been increasing amid doubts about whether it can control spending while also rekindling economic growth. The government successfully sold around $4 billion of short-term bonds on Tuesday — but the interest rate Spain must pay to attract investors has nearly doubled in a month.
After a short respite, euro-zone officials are again seeking to reassure financial markets, calling on investors to be “rational” and assuring that Spain will successfully carry out promised economic overhauls.
The IMF has often warned countries that “fiscal consolidation” could hurt growth, but the message delivered Tuesday was more explicit.
Carlo Cottarelli, the IMF’s fiscal affairs director, said many developed countries should focus on gradually reducing their heavy debt loads rather than trying to take dramatic steps aimed at bringing debt down to the relatively low levels that preceded the 2008 global financial crisis.
The agency’s research has implications for the U.S. IMF officials said that steep tax increases scheduled to kick-in next year were “excessive.” IMF officials urged the U.S. to find ways to spread deficit reduction over several years and thus avoid harming short term growth.
For countries like Spain, government austerity has failed to deliver lower interest rates and a rebound in private economic activity.
At a Tuesday news briefing, IMF economic counselor Olivier Blanchard said that European nations have been pressured by investors to control public borrowing, then pressured as well when budget cuts led to faltering growth. “You’re damned if you do, damned if you don’t,” he said.
In Spain, where the government of Prime Minister Mariano Rajoy is battling to meet strict deficit targets, “a slightly more moderate adjustment . . . would have been preferable,” the IMF said in its latest Fiscal Monitor, an overview of public debt issues.
Bank of Spain governor Miguel Angel Fernandez Ordonez said in Madrid on Tuesday that the government was intent on meeting deficit targets set in consultation with other European nations, most notably Germany, which has pushed for stricter fiscal discipline throughout the euro region.
“Things will get much worse if Spain doesn’t reach the budget deficit targets,” Ordonez told the Spanish parliament, according to wire service reports. The country’s economy, the fourth biggest in the euro zone, is expected to shrink by 1.9 percent this year and barely eke out growth, of 0.1 percent, in 2013, according to the latest IMF projections.
Ordonez’s comments, and the IMF’s new research, are part of a long-standing debate that has divided Europe’s politicians, economists and social activists. The issue is how cash-strapped governments can retain the confidence of private investors — and thus avoid an international bailout — while also avoiding budget cuts and tax hikes so steep that they wreck economic growth.
Cottarelli said the paper released Tuesday amplified themes the IMF has raised before, and he emphasized that nations such as Greece, which had all but lost the ability to borrow money on its own, had little choice but austerity.
But the research also shows how the Europe’s current difficulties are shaping the understanding of how government austerity can affect growth.
Economists know that a reduction in government spending will damage growth to some degree, at least in the short term, as agencies pay less to workers or private suppliers and leave them, in turn, with less to spend or invest. Government spending cuts can also have a positive impact if they lead to less government borrowing, lower interest rates and reduce taxes — and leave more money in private hands.
IMF officials have concluded that current austerity measures are having a particularly large impact on growth because they come amid an economic downturn, with households short of money to spend and nations unable to boost trade by devaluing their local currency.
“The negative impact of tightening may be amplified by some features of the current economic landscape,” the agency study concluded. Recent rounds of cuts “reinforce the economic cycle and thereby exacerbate the slump in growth.”
In Greece, which adopted deep budget cuts and sharp tax increases in return for an international bailout, the economy has contracted much more than IMF models predicted and has been slower to rebound.
When the country needed a second bailout, the IMF and other European nations agreed to extend the program by an extra year so the adjustment could take place more slowly.