Smith Faculty Opinion Article
April 17, 2012
Spain Predicament Show the Perils of Austerity,
Tough Limits on Central Banks
Spain’s economy is teetering on collapse, and its journey shows how strict
controls on central banks and budget deficits—advocated by some U.S.
conservatives—can wreck an economy.
Unlike Italy and Greece, Spain did not unravel because Madrid borrowed to
finance a welfare state it could not afford.
Like the United States in the 2000s, Spain had a real estate boom caused by
efforts to encourage home ownership and Northern Europeans seeking vacations and
second homes in its warm climate. Much was financed by private foreign
investments in Spanish bonds and banks. Tourism and construction boomed, growth
was stronger and unemployment lower than most of Europe. Private debt soared but
Spain’s government enjoyed budget surpluses.
As in the United States, when the real estate bubble burst, banks could not
attract deposits or sell securities backed by loans to maintain liquidity, and
In 2008, the Federal Reserve began lending U.S. banks hundreds of billions of
dollars against loans and securities backed by mortgages, business and auto
loans, and credit card debt. Essentially, the Fed ran the printing presses to
bail out U.S. banks. Critics like Congressman Ron Paul predicted a burst of
inflation would follow and advocated tighter control on the Fed, or even
abolishing it and returning to the gold standard.
The great inflation never came. Any first-year graduate student in economics
knows, full employment is required for more money to create with certainty
additional inflation. What additional inflation the United States endured was
instigated by commodity prices driven higher by growth in China.
Spain was operating under the kind of regime advocated by Fed critics. Using
the euro, the Bank of Spain could not print money to bail out banks.
Instead, the national government borrowed in bond markets to lend to banks.
Its budget swung from a 1.9 percent of GDP surplus in 2007 to an 11.2 percent
deficit in 2009. And Madrid was in no position to borrow further to finance the
kind of aggressive stimulus spending Barack Obama pursued to soften the
Although Spain’s accumulated debt to GDP ratio was more modest than troubled
Italy or even Germany, the United Kingdom, France, bond investors and European
Union governments insisted Spain slash government spending quickly—take the
austerity pill—to get its deficit down quickly.
Madrid got its budget gap down to 8.5 percent of GDP in 2011, and the targets
are 5.3 and 3 percent for 2012 and 2013.
In the United States, thanks to Fed actions and stimulus spending, the
economy is growing, albeit modestly, and unemployment has retreated to 8.2
In Spain, with consumer spending weight down by debt and public spending
slashed, growth is near zero, unemployment is 22.8 percent, and young
professionals are leaving for Brazil and other countries with better prospects.
Private investment is stagnant, and the long-term prognosis is for gradual
Spain is implementing structural reforms to free up labor markets, but those
are hardly enough in the face of slash and burn fiscal policies that are gutting
education and public investments in a nation that sorely needs to bring
educational attainment and infrastructure in line with more prosperous European
More recently, the European Central Bank has been lending aggressively to
Spanish and other European banks but it lacks the regulatory clout fully
empowered national central banks would enjoy to force commercial bank
restructuring and recapitalization—its loans are band aids in a rapidly
deteriorating situation throughout Europe.
In Spain, the government is cutting spending too quickly—even though prior to
the crisis outlays was not excessive in the manner of France, Italy and
Greece—and consequently, its economy can’t grow. Much capital is idle and will
rust from disuse, and Spain’s economic muscle atrophies.
American conservatives who would require balance budgets at times of full
employment, and permit only modest deficits during recessions, and their more
extreme brethren who would gut Fed powers or return the gold standard, have a
marvelous demonstration project in Spain.
During the Great Depression, U.S. unemployment peaked at 24.9 percent. My bet
is Spain will break that record soon. Its leaders should invite Congressman Paul
and his followers to a grand ball to note the occasion.
Peter Morici is a professor at the University
of Maryland School of Business and former Chief Economist at the U.S. International