How austerity was based on market panic

Markets were full of fear. When that receded, so did the bond spreads.

When countries across Europe were putting together austerity policies in 2011, the orthodox reasoning was that the debt and deficit of the nations were out of control, and that this was being communicated by the markets, in the form of bond yields.

But did nations actually base their estimates of the need for austerity on the fiscal fundamentals? Or were they misled by market reaction? A research paper from Paul De Grauwe and Yuemei Ji breaks down the question.

It's certainly the case that the austerity was based, almost entirely, on the state of the market. The authors compare the extent of austerity measures in 2011 with the spreads of the nations' bonds (the difference between each country’s 10-year government bond rate and the German 10-year government bond rate), and find a near-perfect correlation:

Austerity measures and spreads in 2011

The authors write:

There can be little doubt. Financial markets exerted different degrees of pressure on countries. By raising the spreads they forced some countries to engage in severe austerity programs. Other countries did not experience increases in spreads and as a result did not feel much urge to apply the austerity medicine.

Now, that in itself is not particularly problematic. After all, if the financial markets are rationally responding to problems in the respective nations' finances, then it makes sense to try and calm them by getting finances under control. But if the markets are instead in the throes of irrational panic, then basing policy around their whims is problematic.

Ji and de Grauwe then come up with two proxies to test what it actually was which was driving the financial markets. If the markets are acting rationally, then as fundamentals improve, the spreads should fall. So, starting in mid-2012, they compare the change in debt-to-GDP ratio (just one possible measure of fiscal health) to the change in spread values.

They find that, over the period they're examining, debt-to-GDP ratio increases in every one of the ten nations they study. Despite this, however, the spreads decrease in each — and those decreases aren't particularly correlated with the debt-to-GDP change:


Change in debt-to-GDP ratio vs. spreads since 2012Q2

The bond markets don't appear to pay much attention to the basic financial health of the nations. What they do pay attention to is the European Central Bank. The paper states that:

The decision by the ECB in 2012 to commit itself to unlimited support of the government bond markets was a game changer in the Eurozone. It had dramatic effects. By taking away the intense existential fears that the collapse of the Eurozone was imminent the ECB’s lender of last resort commitment pacified government bond markets and led to a strong decline in the spreads of the Eurozone countries.

In the summer of 2012, the ECB removed fear from the equation. What happened then was a widespread collapse in bond spreads. But the collapse wasn't uniform; instead, "countries whose spread had climbed the most prior to the ECB announcement experienced the strongest decline in their spreads". By taking away panic, the ECB lets us see that almost all of the prior variation in the bond spreads had been as a result of that panic.

Basing policy on calm sensible market reactions might work; basing it on the reaction of markets in existential fear probably wouldn't. That's traditionally the time when politicians start trying to lead markets, rather than follow them. And, sure enough, the authors repeat a calculation confirmed by many others: panic-driven austerity has crushed growth in the nations it's been practiced…

Austerity and GDP growth 2011-2012

…and has hurt fiscal fundamentals in those same nations, with debt-to-GDP ratios getting worse the more austerity is practiced:


Austerity and increases in debt-to-GDP ratios

The TUC's Duncan Weldon (whose tweets first pointed me to the research) sums up the lessons we've learned:

  1. Financial markets are perfectly capable of acting irrationally. Market panic drove extreme austerity in Southern Europe.
  2. Extreme austerity has proved self-defeating – it means debt/GDP ratios are higher not lower.
  3. Markets, to quote the IMF’s Chief Economist, can be ‘schizophrenic’ – they initially reward harsh austerity measures and then panic when they, predictably, lead to weaker growth.
  4. The end result is that market panic, followed by policy-maker panic, has imposed huge economic and social costs across Europe

Seems like if politicians really really want to base their decisions on the ill-thought-out panic of large numbers of people, they ought to at least wait for an election.

Gambling with out future. Photograph: Getty Images

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

Photo: Getty Images
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The hidden crisis in the National Health Service

Hospitals are no longer safe places for their staff, warns Simon Danczuk.

It feels as though not a week can pass without the media warning of a fresh “crisis in the NHS”.

But while funding shortages and the impending junior doctor strike are rightly cause for concern, another major crisis is going largely unnoticed.

Figures show that 43 per cent of A&E staff have been physically assaulted at work. Every eight minutes there is some sort of violent incident in a UK hospital.

This is unacceptable, but unfortunately cases of violence against NHS workers seem to be on the increase while the government turns a blind eye to this problem of its own making.

Plotting a graph would show a startling correlation between insufficient NHS funding and the number of doctors and nurses being attacked. As NHS budgets reach breaking point, so too do many patients.

The issue, which will be highlighted in the documentary A&E: When Patients Attack, which airs tonight on Channel 5 at 10pm, is a national scandal.

Health experts suggest that the problem can be directly linked to longer waiting times and staff cutbacks, leading to growing frustration and tension in A&E and other departments. With winter fast approaching, and the notoriously busy festive season to come, incidents of violence look set to get worse. Nobody, least of all our overworked NHS doctors and nurses, should face the prospect of going to work to be attacked, spat at or insulted.

Based at the Queen Elizabeth in Birmingham, one of the country’s biggest hospitals, When Patients Attack follows a security team which uses uniformed guards and a bank of CCTV monitors to keep hospital staff safe.

The sight of a uniformed private security team in an NHS hospital is visually jarring, it would look more at home in a high-security prison than in a place of care and compassion. But the sad reality is, guards like this are a necessary part of the NHS under a Tory Government.

A&E centres across the UK, including the one in Rochdale, are being closed or consolidated creating extra journey times for patients and more pressure on those that remain.

But there is a gaping logical flaw here. NHS trusts are spending money, which should be on patient care, on employing security staff to deal with the fallout from cuts in care.

Seeing the level of physical, verbal and racial abuse that doctors and nurses have to endure makes When Patients Attack hard to watch at times. What is clear is that many of the patients featured are not lashing out for some malicious reason, they are vulnerable and bewildered people in need of care.

Many have learning difficulties or mental health problems, others are disorientated or in pain, there are those under the influence of drink or drugs and some just have nowhere else to go. A significant amount on the security team’s time seems to be spent convincing patients who have been discharged to leave the premises.

Here we see a less obvious example of how Conservative cuts are impacting on our NHS. Hospitals are always open and always welcoming. The duty of care means that no one is turned away. As a result, they are filling the void left by homelessness shelters and local government social services.

David Cameron has made much of the Government’s plan to put mental and physical health on an “equal footing”. But this will remain little more than empty rhetoric as long as those suffering from serious and complex mental health issues continue to seek help at A&E because of a lack of any alternative.

It is not just cuts to councils and the health service that have created this epidemic of NHS violence. In my constituency of Rochdale alone, Greater Manchester Police has been forced to withdraw 150 officers from the beat because of budget cuts. Business owners and members of the public have told me that Police response times have increased dramatically since 2010. It is important that violent incidents are diffused as quickly as possible and while an in-house security team is helpful, the additional support of trained Police officers is vital. Each additional minute that NHS staff have to wait for the Police increases the risk that a situation will escalate and become more serious.

Jeremy Hunt speaks of a seven-day-a-week NHS. But these grand plans ring hollow when we see the reality on the ground in the NHS today. This government cannot even guarantee that staff can work without the fear of physical harm. Our doctors and nurses are among the hardest working people in any community. The very least they can expect is to be able to care for us in a comfortable, supportive, and above all safe, environment.


Simon Danczuk is Labour MP for Rochdale