At its 40th annual Economics Conference, the Oesterreichische Nationalbank (OeNB) spotlights the economic policy implications of the current European sovereign debt crisis. “Recent developments in international bond markets indicate that unfortunately, the fiscal problems in the euro area cannot be considered to be completely solved yet,” OeNB Governor Ewald Nowotny said in his opening remarks.
Several euro area countries are currently facing credibility problems, which are associated with high risk premiums. In such an environment, very high debt levels, caused in part by the consequences of the recession, call for significant fiscal consolidation programs. The ensuing social and political instability and weakened economic growth in turn unsettle international creditors, impairing the positive effect of consolidation. One lesson of the most recent consolidation effort should be that “consolidation programs must be seen in the context of growth prospects,” established Governor Nowotny. In particular, policymakers must take account of the effects of fiscal consolidation measures over time: in the short run, they dampen growth, whereas they boost growth in the long run. These delayed effects make it necessary to take recourse to “external policy intervention.”
Consequently, the help of the European and international community of states appears to be indispensable. At the same time, it is important to create suitable incentives for the countries concerned to implement the necessary comprehensive structural economic reforms. Hence, these countries must choose the best possible reform path to ensure that the reforms are in fact politically sustainable and to prevent any renewed negative impact on market confidence.
Decision making in the European Union (EU) to cope with the crisis is frequently criticized as being a drawn-out and unwieldy process. “We must not forget, however, that in the end, we are still dealing with sovereign democracies in the EU and in the euro area,” Nowotny emphasized. Reforms and assistance programs must be accepted and supported by national parliaments and citizens in both debtor and creditor countries. In addition, this criticism fails to recognize that the EU has taken far-reaching steps both to address the crisis and to reform the economic policy framework. Undeniably, European policymakers’ response to the crisis has greatly advanced European integration – this much has become clear. “The current debt crisis heralds a new era for the European economic and political architecture,” announced Nowotny. The current problems resulting from the crisis are difficult to resolve, but if the efforts are successful, they have an enormous potential to let Europe emerge from the crisis with renewed economic and political strength. “The crisis could be used to overcome the dominance of national interests and to create an even more strongly integrated EU,” Nowotny suggested.
The debt crisis is also a reminder that banking crises affect the real economy severely and for long periods. Therefore, policymakers will need to focus their efforts more strongly on optimizing the financial market regulation framework.