For Immediate Release
Dan Beeton, 202-239-1460
New Report Suggests Stimulus Better for Spanish Economy, Debt Burden, Than Austerity
WASHINGTON - A new report
from the Center for Economic and Policy Research (CEPR) shows that
Spain, under pressure to cut spending and raise taxes while its economy
is barely recovering, might be better off with a continued stimulus.
"The planned budget cuts and tax
increases in Spain are not only unnecessary, but socially and
economically destructive," said economist Mark Weisbrot, Co-Director of CEPR and lead author of the report, "Alternatives to Fiscal Austerity in Spain". "They also could easily leave Spain with a worse debt problem than they would have with a continued fiscal stimulus."
Spain's unemployment rate has shot up
from 8.5 percent in 2007 to more than 20 percent today after the
collapse of large housing and stock market bubbles. The paper shows that
the bursting of these bubbles, and the resulting collapse of private
demand, is the cause of Spain's current economic and budget problems -
not government overspending.
The report argues that continued fiscal
stimulus could be financed by the European Central Bank, through money
creation, much as the U.S. Federal reserve has done over the past three
years, and the Bank of Japan has done since the 1990s. Even if financed
through ordinary borrowing, the projections in the paper find that
Spain's debt-to-GDP ratio would not end up much higher in 2020 if the
government continued a stimulus over the next two years, than under the
current planned fiscal tightening.
The report provides projections for
scenarios in which the fiscal tightening leads to slower growth and,
therefore, higher borrowing costs for the government. These lead to
higher debt-to-GDP ratios than would occur under a continued stimulus
"With these depression-level
unemployment rates, the government's first priority should be creating
and maintaining employment, not fiscal tightening," said Weisbrot.
The Executive Summary follows:
This paper looks at the planned austerity measures in Spain, the rationale for the spending cuts and
tax increases, likely outcomes for future debt-to-GDP ratios, and the probable results of alternative
It is widely believed that Spain got into trouble because of the over-expansion of government
spending. However, during the economic expansion from 2000-2007, the gross debt-to-GDP ratio
declined sharply, from 59.3 to 36.2 percent of GDP. In 2009, interest payments on Spain's debt
were just 1.8 percent of GDP, a modest interest burden. Net debt had declined to 26.5 percent of
GDP in 2007.
Net debt is a better measure of the country's debt burden than gross debt, because interest that is
paid on debt held by the government accrues to the government, and therefore does not represent a
burden on government finances. In this paper we will use both figures, because the gross debt
figures are most commonly cited in the press.
The cause of Spain's current debt problems, as well as its unemployment and weak recovery, was
thus not an over-expansion of government but the collapse of private demand. The country had
built up a large housing bubble that began to collapse in 2007, at the same time that the economy
was hit with external shocks from the world recession. Between 2000 and 2006, construction
increased from 7.5 percent of GDP to a peak of 10.8 percent. Since the collapse, housing starts have
fallen by more than 87 percent from their peak.
Spain also suffered from the collapse of an enormous stock market bubble: the stock market peaked
at 125 percent of GDP in November 2007 and dropped to 54 percent of GDP a year later. The
wealth effect of this huge drop in stock values would be expected to be very large, in the range of a
1.3 - 1.75 percent fall-off in GDP.
Unemployment has risen from 8.5 percent to over 20 percent, and is projected to be at 15.5 percent
at the end of 2013.
For an alternative to current pro-cyclical policies, we consider two versions of a continued fiscal
stimulus, amounting to 3.9 percent of GDP over the next two years, as compared to the baseline
In the first alternative, the European Central Bank (ECB) buys debt equal to 4 percent of GDP
annually over two years. This would be done with an agreement to refund the interest payments on
the debt to the Spanish government.
Although the ECB and European authorities - which currently includes the IMF for these decisions
- would be unlikely to carry out this policy, it is important to illustrate because it shows that there is
a simple, feasible alternative to present policies that does not lead to an unsustainable debt burden.
In this case, the net debt-to-GDP ratio increases to just 60.5 percent of GDP in 2020, as compared
to 64.3 percent of GDP in the baseline scenario based on the government's projections.
The feasibility of such an approach must be emphasized. The U.S. Federal Reserve has added more
than one trillion dollars to its balance sheet - thus more than doubling it - since the U.S. recession
began. There has been no threat to inflation resulting from this money creation. The Bank of Japan
has financed trillions of dollars of debt since the 1990s by creating money, with the result that there
is a more than 100 percentage point (of GDP) difference between the government's gross and net
debt; and yet inflation has been extremely low in Japan over the past 20 years and sometimes
negative. Consumer price inflation in Europe is currently at about one percent.
In the second alternative, the continued stimulus is the same size but is financed through regular
borrowing, rather than money creation by the ECB as described above. In this scenario the net debt
is significantly higher, increasing to 68.3 percent of GDP by 2020. It is worth noting, however, that
this is just four percentage points higher than the government's baseline scenario.
The government currently plans budget cuts and tax increases, which it projects will stabilize the
gross debt-to-GDP ratio at 69 percent of GDP by 2013 (net debt at 62.4 percent). However, there
are many historical examples in which growth turned out to be seriously overestimated when procyclical
policies were implemented. For example, Ireland began reducing its fiscal deficit at the end
of 2008. At the time, the IMF projected 1 percent growth for 2009; the actual result was negative 10
Furthermore, if the planned pro-cyclical policies result in slower growth or push the economy back
into recession, this could cause the interest rate on new debt for Spain to rise. In this paper we look
at three scenarios that incorporate a lower growth projection, with interest rates of 6, 7, and 8
percent on Spain's debt. In these scenarios, Spain's gross debt-to-GDP ratio rises to 85.5, 90.6, and
96.1 percent of GDP, respectively, by 2020. Net debt rises to 76.6, 81.7, and 87.2 percent of GDP,
Thus, there are plausible scenarios under which the planned pro-cyclical policies can lead to much
higher debt levels than would result from the continuation of a moderate fiscal stimulus. Even from
the point of view of avoiding unsustainable debt accumulation, the risk of a prolonged stagnation -
combined with higher interest rates - may be much greater than the risks associated with countercyclical
fiscal policy at present. And the alternative, feasible counter-cyclical policies would avoid
much of the social and economic costs of lost output and prolonged high unemployment that Spain
The Center for Economic and Policy Research (CEPR) was established in 1999 to promote democratic debate on the most important economic and social issues that affect people's lives. In order for citizens to effectively exercise their voices in a democracy, they should be informed about the problems and choices that they face. CEPR is committed to presenting issues in an accurate and understandable manner, so that the public is better prepared to choose among the various policy options.