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.

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Is there such a thing as responsible betting?

Punters are encouraged to bet responsibly. What a laugh that is. It’s like encouraging drunks to get drunk responsibly, to crash our cars responsibly, murder each other responsibly.

I try not to watch the commercials between matches, or the studio discussions, or anything really, before or after, except for the match itself. And yet there is one person I never manage to escape properly – Ray Winstone. His cracked face, his mesmerising voice, his endlessly repeated spiel follow me across the room as I escape for the lav, the kitchen, the drinks cupboard.

I’m not sure which betting company he is shouting about, there are just so many of them, offering incredible odds and supposedly free bets. In the past six years, since the laws changed, TV betting adverts have increased by 600 per cent, all offering amazingly simple ways to lose money with just one tap on a smartphone.

The one I hate is the ad for BetVictor. The man who has been fronting it, appearing at windows or on roofs, who I assume is Victor, is just so slimy and horrible.

Betting firms are the ultimate football parasites, second in wealth only to kit manufacturers. They have perfected the capitalist’s art of using OPM (Other People’s Money). They’re not directly involved in football – say, in training or managing – yet they make millions off the back of its popularity. Many of the firms are based offshore in Gibraltar.

Football betting is not new. In the Fifties, my job every week at five o’clock was to sit beside my father’s bed, where he lay paralysed with MS, and write down the football results as they were read out on Sports Report. I had not to breathe, make silly remarks or guess the score. By the inflection in the announcer’s voice you could tell if it was an away win.

Earlier in the week I had filled in his Treble Chance on the Littlewoods pools. The “treble” part was because you had three chances: three points if the game you picked was a score draw, two for a goalless draw and one point for a home or away win. You chose eight games and had to reach 24 points, or as near as possible, then you were in the money.

“Not a damn sausage,” my father would say every week, once I’d marked and handed him back his predictions. He never did win a sausage.

Football pools began in the 1920s, the main ones being Littlewoods and Vernons, both based in Liverpool. They gave employment to thousands of bright young women who checked the results and sang in company choirs in their spare time. Each firm spent millions on advertising. In 1935, Littlewoods flew an aeroplane over London with a banner saying: Littlewoods Above All!

Postwar, they blossomed again, taking in £50m a year. The nation stopped at five on a Saturday to hear the scores, whether they were interested in football or not, hoping to get rich. BBC Sports Report began in 1948 with John Webster reading the results. James Alexander Gordon took over in 1974 – a voice soon familiar throughout the land.

These past few decades, football pools have been left behind, old-fashioned, low-tech, replaced by online betting using smartphones. The betting industry has totally rebooted itself. You can bet while the match is still on, trying to predict who will get the next goal, the next corner, the next throw-in. I made the last one up, but in theory you can bet instantly, on anything, at any time.

The soft sell is interesting. With the old football pools, we knew it was a remote flutter, hoping to make some money. Today the ads imply that betting on football somehow enhances the experience, adds to the enjoyment, involves you in the game itself, hence they show lads all together, drinking and laughing and putting on bets.

At the same time, punters are encouraged to do it responsibly. What a laugh that is. It’s like encouraging drunks to get drunk responsibly, to crash our cars responsibly, murder each other responsibly. Responsibly and respect are now two of the most meaningless words in the football language. People have been gambling, in some form, since the beginning, watching two raindrops drip down inside the cave, lying around in Roman bathhouses playing games. All they’ve done is to change the technology. You have to respect that.

Hunter Davies is a journalist, broadcaster and profilic author perhaps best known for writing about the Beatles. He is an ardent Tottenham fan and writes a regular column on football for the New Statesman.

This article first appeared in the 05 February 2015 issue of the New Statesman, Putin's war