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Hungary's Defiance of IMF and European Authorities Scares the Guardians of Austerity in Europe
The government of Hungary has taken on a lot of powerful interests in the last couple of months, and so far appears to be winning - despite provoking outrage from everybody who's anybody.
"The IMF should hold the line," shouted the Financial Times in an editorial the day after Hungary sent the IMF packing in July. "With so many countries in vulnerable positions, it cannot be seen to be a soft touch. Showing a few yellow and red cards is a good way to send a signal to other governments that might be tempted to flirt with indiscipline."
This is the great fear among the defenders of European "pro-cyclical" policies - that is, policies that weaken the economy during a recession or when it is barely growing. Hungary's defiance could conceivably spread to other governments currently being squeezed by the IMF and European authorities.
First, the Hungarian government decided in early July to levy a new tax on banks and other financial companies, which would raise some $855m this year and next. Foreign banks, which made a fortune during Hungary's bubbly growth years prior to the crash in 2007, screamed and lobbied, but - despite having the IMF in their corner - did not prevail.
Then, the government refused to give in to IMF demands for further budget deficit reduction. Hungary has already been through nearly four years of austerity in which the deficit was reduced from 9% to 3.8% of GDP. More importantly, the country's current account deficit - its imbalance with the rest of the world, which was more than 7% of GDP in 2008 - is less than 1% for this year. With unemployment having risen from 7% in 2007 to nearly 12% today, and the economy still barely growing, Hungarians were understandably beginning to wonder when they would see light at the end of this long tunnel. Negotiations with the IMF over conditions for further access to IMF funds broke down on 17 July.
Now, the government of Viktor Orban, whose party won a landslide with more than two-thirds of the Hungarian parliament in April, has taken aim at the country's central bank, blaming it for keeping interest rates too high and thereby delaying the recovery. The government cut the salary of the Andras Simor, the governor of the central bank, by 75%. (If only we could have done that to Alan Greenspan or Ben Bernanke, just to make an example out of them for missing the two biggest asset bubbles in world history and thus guaranteeing our worst recession since the Great Depression.) The central bank is holding policy interest rates at 5.25%, one of the highest in Europe (compare this to our own Federal Reserve's policy rate of 0-0.25%, since the end of 2008).
All of these decisions by the Orban government have some economic logic to them. The bank tax amounts to about 0.5% of GDP, which is significant for a government that is trying to reduce the deficit; and the banks - whose reckless lending practices, as in the United States and elsewhere, had a lot to do with causing the mess that Hungary faces - are already profitable even as the economy is still stagnating. This is a good place to collect taxes. The pro-cyclical policies demanded by the IMF (budget cuts and tax increases) have kept the economy from recovering; at some point, someone has to say "enough is enough".
And the same is true for the central bank's high interest rates: they have been much too high through most of the downturn, between 8 and 11.5% in 2008, while the economy was in decline. Last year, Hungary's GDP fell by 6.3%, while policy rates were still between 6.25 and 9.5%. A crash of this magnitude, with the economy barely growing this year, indicates policy failure.
But the government's actions have elicited harsh rebuke from on high. The standard orthodoxy is that central banks must be "independent" of the government - which often means that they look out for the interests of bankers rather than the general public.
Credit rating agencies such as Moody's and Standard & Poors - the folks who brought us triple-A rated toxic junk in the form of mortgage-backed securities a couple of years ago - have put Hungary on review for possible downgrade due to its failure to reach agreement with the IMF. As the New York Times reported last week, the fight in Hungary "reflects a larger struggle that is expected to play out over the next year or so as most European politicians... seek to impose fiscal discipline on their increasingly unruly citizens."
We can only hope that they get more unruly. The governments of Spain and Greece, for example, have a lot more bargaining power and a lot more alternatives than they have been willing to use.
It is ironic that a centre-right government in Hungary has taken the lead here; but if the socialist governments of Spain and Greece were to stand up to the European authorities and the IMF, they could also rally popular support. And then we would see a new playing field in Europe that would allow for a more rapid recovery, and possibly end the current assault on the living standards of the majority.