Austerity, Debt-Deleveraging, And Why 'Muddle-Through' Fails

Tyler Durden's picture

The debt levels of advanced economies remains unsustainably high - bringing with it the considerable risk of renewed crisis - and while strong growth is the best way to deleverage, this solution appears out of reach for most (if not all) economies. Financial repression, austerity, inflation, or default are the remaining options - all of which come with considerable costs to economic growth and employment. While 'muddling-through' appears to be heralded as a positive by many market-savants currently, SocGen notes that the line between a virtuous (expansionary fiscal contraction) and vicious austerity trap comes down largely to policy confidence. Most (if not all) advanced economy politicians entirely lack the public's or market's confidence in credible policy direction (and in fact we are seeing policy uncertainty at extremes) which leads to SocGen's conclusion that the muddle-through strategy (which comes with a high price tag economically and socially) is too high a burden politically and will inevitably lead to spillover to core-Europe and the global financial system.


 Austerity: Short-term, we are Keynesians

Securing a credible path for future public finances comes with many positives for economic growth. Ricardian equivalence suggests that economic agents “internalise” the governments’ inter-temporal budget constraints. As such whether governments fund expenditure via tax hikes or debt should be neutral as consumers would respond to the latter by increasing savings in anticipation of future tax hikes. This is also the theory behind the idea of “expansionary fiscal contraction”, which suggests that by reducing expectations for future potentially distorting tax hikes and lowering interest rate risk premia, fiscal austerity today can thus encourage private consumption and investment. As the latter is generally seen as more conductive to economic growth than public spending, overall GDP should thus be boosted by austerity. This is very much the philosophy behind the “German Diet” of fiscal austerity, structural reform and wage restraint.



However, this contrasts with what has been observed in the euro area to date; namely that fiscal austerity (at least in the short term) has been dominated by Keynesian effects, i.e. austerity comes at a cost to GDP growth. As a rule of thumb, the IMF (WEO, October 2010) finds that past fiscal consolidation has exerted a multiplier effect of 0.5, i.e. 1% of GDP of fiscal austerity results within two years in a negative short-term drag on GDP of 0.5pp, raises the unemployment rate by 0.3pp and lowers domestic demand (consumption and investment) by 1pp. Recent experience, however, suggests that the drag from austerity – notably in the fiscally weaker euro area member states – may be much higher.

Several factors may explain this, including impaired monetary policy transmission, tighter financial sector regulation, external sector adjustments, large output gaps, the composition of consolidation (the how of fiscal austerity), and critically social unrest.

What’s the cost?

“Some debts are fun when you are acquiring them, but none are fun when you set about retiring them”. Ogden Nash

The many facets of debt deleveraging make its analysis a complex exercise. With the aim to further our understanding of deleveraging, SocGen built the SG 3D (Debt Deleveraging Dynamics) model. To our knowledge, it is the first of its kind exploring deleveraging across all sectors of the economies driven by a set of “policy confidence variables” at the core of the model. As with any model, it has limitations but the results are powerful in clearly illustrating that the muddle-through strategy comes with a very high price tag and is thus unlikely to be sustainable for the long run. It is critical that results are delivered soon so that a scenario of “confidence” can kick in.

Three deleveraging scenarios 2011-2030

To estimate the cost of deleveraging, we run three scenarios over the period 2011-2030 in the SG 3D model (1) confidence, (2) muddle-through and (3) no confidence. In the “no confidence” scenario, euro break-up risk would increase substantially.

  1. Muddle-through: It will take time to see that the policy strategy of structural reform and austerity in the euro area can (ultimately) work and that this will happen only as successes become visible in places like Portugal and Ireland. In the US, deleveraging Federal debt will remain something of a bumpy ride. The US and the UK, notably, will continue to enjoy the benefits of QE in terms of financial repression and thus lowering “snowball” effects. In muddle-through, interest rate risk premia (positive or negative) will converge only very slowly to long-term equilibrium. Interest rate multipliers are assumed to only improve slowly as banking sector repair gets underway.
  2. Confidence: Boosted by credible policy, and notably by a fast-tracking of reforms to build a credible banking and fiscal union in the euro area, interest rate risk premia decline sharply, lowering the necessary fiscal adjustment. Trend potential growth is boosted by fast-track structural reform and the interest rate multiplier returns to normal working order as credit channels again become fully functional. Looking at the current Stability and Growth Pact programs, this scenario rather than a muddle-through appears to be closer to what many of the governments have assumed in their forecasts. In our opinion, however, this scenario is unlikely to materialise anytime soon unless there is a sharp and accelerated shift towards more credible polices; something that seems unlikely near-term.
  3. No confidence: In many ways, this scenario describes the current path with high and growing interest rate risk premia on the European peripherals slowly spilling over to the core markets as confidence is lost in the muddle-through scenario. The economic pain in the European periphery that would result from attempting to target deleveraging under this scenario would be politically unfeasible and, as a result, default would follow. As indicated above, our aim is not to model euro area break-up per se, but in this “no confidence” scenario, it seems reasonable to expect a number of countries would be forced to exit.

The results from the three simulations in terms of GDP growth per capita are summarized in chart 3.1 below. We caution that these results are not intended as forecasts, but as an analysis of the burden of deleveraging in terms of economic growth.



A first positive observation is that under a credible policy framework, returning the advanced economies to healthy levels of per capita GDP growth is easily within reach. For the European economies, in particular, however, this requires achieving structural reforms. The reward comes with both lower interest rate premia and higher growth rates. A confidence scenario would see the crisis quickly behind us and interestingly is in many ways the outcome suggested by history (usually with some muddle-through initially).


Imagining a very bleak scenario of two decades with little, none, or even negative GDP growth does not require much of a stretch of the model variables. For the European periphery, it just requires that current conditions persist medium-term, then spillover to core-Europe and the global financial system. This should serve as a strong warning of the need to act now to prevent such an outcome from materializing. Indeed, while the current muddle-through is survivable for now, it is not sustainable medium-term - since the chart below shows the impact of the 'required' structural reforms which would provide the confidence the market needs...



In the no confidence scenario, the austerity trap hits with full force. Under this scenario, the burden of deleveraging in the European periphery becomes so intense that there is no option but to default, which carries its own cost. The no confidence scenario also sees default in Japan; here, however, the default is primarily “internal”. In an aging population, this would be painful, seeing large chucks of savings wiped out.

While inflation is present in this first version of the SG 3D model, we have opted not to run an inflation scenario as this would also merit the inclusion of a model of exchange rates, a development we plan for the second edition. The mechanics of an inflation scenario have many similarities to a painful adjustment coming with many of the features of an austerity trap. Seniorage is in many ways just an alternative means of defaulting.


Critically then, without policy confidence 'muddle-through' will keep leaking back to unsustainable crises; and with the burden of the required structural reforms (given even aggressive growth expectations) policy-makers are highly unlikely to gain and keep the public's confidence in order to jump the chasm from Austerity Trap to expansionary fiscal contraction.


Source: Societe Generale

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buzzsaw99's picture

save the bankers and all will be well. blah, blah, blah

Ahmeexnal's picture

Norwegian summer in the works as millions of sheeple are being robbed of their wealth:

NORWAY’S SOVEREIGN wealth fund, Europe’s largest stock investor, lost 77 billion kroner (€10.6 billion) in the second quarter as stocks slumped on concern the region’s deepening debt crisis would derail the global economy.

The €505.6 billion Government Pension Fund Global fell 2.2 per cent, as measured by a basket of currencies, the Oslo-based investor said yesterday. Its equity investments fell 4.6 per cent, while its bonds returned 1.5 per cent.

Norway’s government deposited 72 billion kroner of oil revenue into the fund in the quarter.

buzzsaw99's picture

norway teacher's pension fund gave paulson and the squid untold billions. I'd be willing to bet that the same stupid corrupt bozo manager of that fund is still in charge and still buys chit from the squid the same way jefferson county still does business with jpm. muppets is as muppets does and ain't nobody gonna change that until it all crashes down.

old naughty's picture

I say we are in "expansionary non-confidence"...

Crash looming.

Element's picture

Let me guess; 

Without even reading it (so far), this article describes the impact of spiral falls in aggregate demand, due to shit that we rightfully should not have been buying on credit, in the first instance, but was simply the product of neurotic advertising Pavlov's-Doggie-style destructive psychological over-stimulus and resulting greed (inducing generalised Creutzfeldt-Jakob-Canine-Spongiform-Encephalopathy), as it's fundamentally nothing but a thinly disguised malinvestment at a personal level, and a thinly disguised but lagging-by-decades inevitable GDP capsize at the macro level?

Eerie huh? 


EDIT:  read it and I was right ... who-cuda-knowed unaffordable debt, due to delibereately promoted malinvestement, in every strata of society, and Govt,  would end up like this? ... and so they erect this laughable pretend 'cover-story', dat evens dah no-bell prise winnah cud not see eeny of dis coming, so how could dah bankster-er, and dah political shitbird-ery?

yeah .... rriiiiiiighht!

Zero Govt's picture

"..policy-makers are highly unlikely to gain and keep the public's confidence in order to jump the chasm from Austerity Trap to expansionary fiscal contraction"

How long will the bwankers ratchet (Govt) maintain credibility amongst the public it thieves from and impoverishes, before the smarmy face/fraud of Govt drops, it's all about the bwankers?

70% of US debt is interest due, paid for through the Fed/IRS tapping into societies pockets 

and what have the bwankers had to do to thieve societies wealth?

...push some paper around a desk, dress up fraud and a monopoly on money is some fancy names and trick a few ignorant politicians and 'Hey Presto' you own the current and future productive output of a whole nation for decades ...nice 'work' if you can get/ratchet it

Landrew's picture

"70% of US debt is interest due" Sorry that is so wrong interest on total U.S. debt is this year +- 500 billion. Total income is 2.4 Trillion. Now if your point is, if the interest rate on the 5 yr. note rises to 6% interest on the total debt would wipe out all income that would be a true statement if I have my numbers correct.

vinoverde's picture

I cannot even understand the headline. What, pray tell, is an expansionary fiscal contraction?




Fluffybunny's picture

How about forgetting austerity (slashing spending and raising taxes) as well as keynesian gimmicks (increased spending and some tax cuts), and instead cutting taxes and slashing spending?

Zero Govt's picture

How about going for the jugular, sorting the problem once and for all, and slashing Govt out of society?

Game/s Over.

CrashisOptimistic's picture

You do realize tax rates are at a more or less all time low?  The Bush rates are still in force and the SS tax rate's slash is still in effect.  

All it got was 1.5% Q2 GDP.

You wanna cut spending?  No problem.  How much?  The deficit is 1.4T so how much you want to cut?  How about $500Billion?  That's 3.3% of GDP.

That will transform that 1.5% Q2 GDP into -1.8% GDP.  Know what that will do to tax revs?

Wrap your mind around a particular concept.  There Is No Conservative Answer -- andddd There Is No Left Wing, Progressive, Liberal Answer.

 People Have To Die to make this work.

Everyman's picture

So what you are saying is that people ARE in fact, GOING TO DIE?  Because this will "work istelf out", value WILL be established, and debts if not paid, means somone goes hungry.

Yes, it IS a cut to GDP, but this SHOULD NOT BE IN GDP anyway.  Who in the HELL had the brilliant idea to have so much Gov't. spending as part of "GDP"????  What "does" the Gov't. "produce", otherthan ideas and concepts that are corrupt and don;'t work?  You don't want to cut fat bloated programs that are ineffective?

Money_for_Nothing's picture

Use to be taxes didn't apply to unemployment insurance. Now they do. The person who said "US taxes everything" was right (Hillary Clinton). Taxes are higher than you believe. tax revs? 100% of nothing is always nothing. A dead horse will not pull a cart. Cut taxes and the hidden economy might come out to play.

Stuck on Zero's picture

Stop falling for that "austerity" line.  The Government seems to think that "austerity" is when they have to cut back on their lavish spending and stop stealing the money from the people.  Another government B.S. term is "stimulus."  Somehow, only a Government could imagine that stealing money from the people to spend on bankers is a "stimulus." 


Money By Trading's picture

Gold can't resist a rising dollar for long.

ebworthen's picture

There will be no solution and only pain and suffering until financial engineering, shadow banking, and central banks are put to death.

Zero Govt's picture

Can be done

Take the toy, Govt, away from the banksters

Stop Paying Your Taxes... Govt (and all the shit that hangs off it) stays only as long as you keep sponsoring it

CrashisOptimistic's picture

Ya, zero tax revenue will do wonders for the deficit.

LawsofPhysics's picture

I always appeciate the math aspect you bring to discussions.  I'll only add that the majority of the debt is fraudulent.   This is what happens when fascists or crony capitalists (if you prefer the PC term) socialize their private losses.

I dream of a day when the owners, management and shareholders have to pay back the creditors when a company is run into the fucking ground.

The average taxpayer is tapped-out, period.  that which cannot be sustained, won't be. 

OneTinSoldier66's picture

+1 Laws.


I think everyone should be doing something about the unathorized debt and deficit spending right now. Buy Gold and Silver.


I wish I would have recognized the ponzi scheme for what it is sooner than I did. That which is unsustainable eventually comes to an end, one way or another.

savagegoose's picture

used to be bond holders where higher priority than shared holders if things blew up. but o well obama changed that.  crony fascism it should be called.

TruthHunter's picture

"Stop Paying Your Taxes... Govt (and all the shit that hangs off it) stays only as long as you keep sponsoring it"

How does that help when they are basically counterfitting much of what they spend?  Tax evasion just exposes you to confiscation.

delacroix's picture

expansionary fiscal contraction? that must be one of those new math terms I don't understand. shoulda got a phd.  do the french know, jerry lewis got fat and died?

lolmao500's picture

All powers belong to me... says Bibi.,7340,L-4267396,00.html

Revised gov't protocol gives PM unprecedented powers

Ministers approve dramatic amendments to government protocol which enable Netanyahu to root out opposition to fateful decisions, delay implementation of approved decisions

Democracy? What's that?

crawldaddy's picture

why are people so brainfucked?  The answer is right in front of you but it cant be spoken?  the answer... TAX THE FUCKING ULTRA RICH..


They have all the fucking money, tax it away from them, they stole it, they didnt earn it.

pies_lancuchowy's picture

Certainly well-intended.. but of course absolutely unfeasible. Because you forgot that TAXES ARE FOR THE LITTLE PEOPLE! Taxes will always hurt the poor the most. Income redistribution ALWAYS goes from the POOR to the RICH. OBama and Romney do not play golf or eat sushi with 50 million minimum-wage folks.. they do it with one 50-million-USD net worth guy. And they scheme how to screw the poor even more!

bank guy in Brussels's picture

Interesting the optimism in this article:

« ... under a credible policy framework, returning the advanced economies to healthy levels of per capita GDP growth is easily within reach ... »

The 'credible policies' in the euro-zone being not just structural reforms but a greater amount of EU integration, it seems, as the article says « ... a fast-tracking of reforms to build a credible banking and fiscal union in the euro area ... »

Quite what the EU authorities, including Germany, have in mind now for the autumn, given that the 'muddle through' phase has somewhat clearly worn out ...

But the key lesson needed for Europe - as the IMF noted about Iceland's success - is not to ravage and abandon the lowest income people, while various reforms and restructuring is undertaken ... if the folks on the bottom rung suffer disproportionately, 'confidence' is pretty damn hard to produce in Europe ... In Iceland they increased support to the most vulnerable while making their transition, and that needs to be priority anywhere in Europe, or in the world for that matter

gwar5's picture

I keep reading more of those depressing reports on complexity theory and the interconnectness of our economy. What is coming is unavoidable so you can officially abandon all hope. Austerity or inflation, it's just not really going to matter much. All we can do is to be individually prepared and not freak out too much when it happens because life will still go on for those that only get shot in the leg. 


Gotta give a shout out to the USA women's Olympic swimmers and track speedsters, who not only won plenty of Olympic medals, but every one of them seemed to be some of the nicest and most genuinely gracious human beings that I've ever seen interviewed. Seriously.

Also, gotta give a shout out to NBC for sticking us with all those non-stop hours of Eastern European countries battling it out in Olympic Rythmic gymnastics and that meaningless Japan vs South Korea vollyball game. WTF??


El's picture

Here's the thing...everyone keeps talking about a need to reduce the debt to a sustainable level. However, if people/countries stop borrowing, then the whole ponzi scheme crumbles. We can't continue going forward and accumulating more debt that we can't pay back, but we can't go backwards and deleverage either without bringing the whole thing down. I think the slogan "It's the economy, stupid" should be changed to "It's the system, stupid." I just don't see where we go from here without dumping this broken debt-based system.

OldPossum's picture


Read David Graeber's "DEBT The First 5'000 Years". OCCUPY lives!

gadzooks's picture

Once again the overattachement of goverment and or monachies to be the leading force of any economy is the main problem ,bureaucracies arn`t the economy they are carried on the coat-tails of a real economy ,thats why they need too adjust themselves accordingly on a downturn and let adjusments,innovations and resetings hit the pavement ,this is fraud and manipulation on the part of power monging thieves who indulge in paranoia and empty the public coffers for themselves .


gadzooks's picture

Next problem ,overlayered yield coverages for witch all good parts of equities and commodoties futures will go to the few financial institutions and will leave crums for everybody else ,bad for us but realy catastrophic

for the working classes of emerging markets,the worst macroeconomic model is being forcably implemented and will surely fuck up everything.

Turin Turambar's picture

If the solution isn't Austrian, it'll FAIL.  It's that simple.

Dollar Bill Hiccup's picture

We need more Zombie shows on television so that we learn to remain calm in the face of the undead.

Zombie banks, zombie sovereigns, zombie jobs for many.

For goodness sake, even ammunition maker Hornady has jumped on the zombie bandwagon with its marketing campaigns.


Meanwhile, back in the real world, we could us a little more reality.


I thought Charlton Heston was great in Omega Man and Will Smith was just ok in I am Legend.

But seriously,  isn't it time we let this zombie thing go?

cdude's picture

Fat, drunk and stupid is no way to go through life, son.

dogismyth's picture

oh for gods sake, can't you read the writing on the wall.


After the election, austerity begins.  Big time.  The markets will roar forward (for a while) on the austerity until they realize the implication...less consumer spending.


The "have nots" and elderly will die at a much higher rate.  Much higher.


The bull market will be in formaldehyde.

StychoKiller's picture

"Dreams Come Due, Government and Economics as if Freedom Mattered", ISBN: 0-671-61159-3, by John Galt -- The book is dated, but many of the things it talks about are still valid today.

GoldandSilverTrain's picture

$40 trillion is the approximate global sovereign debt. Add an average 5% interest rate and we're talking about $2 trillion in interest per year...$2 trillion that has to be collected from taxpayers. It's a disaster and there's only one way out of it: write off all the debt on our tab. All the debt repayment just goes to private bankers who do nothing but debt creation and economic destruction. -tracking and analysis for gold & silver stocks