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
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

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

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

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.

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
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

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