Fiscal Austerity and the Fund: Examining Tensions within the Troika Gabrielle Favorito The European Crisis & Aftermath Professor Henning, School of International Service University Honors Spring 2014 Favorito 1 Abstract Faced with exceptional circumstances in 2010, as Greece, Ireland, and other heavily indebted, stagnant economies plunged into sovereign debt crises, European authorities responded with the creation of a financial support mechanism known as the “Troika”, which consists of representatives from the International Monetary Fund (IMF), the European Central Bank (ECB), and the European Commission (EC). However, the Troika has been challenged both by internal discord over the magnitude and pace of fiscal austerity, as well as by external political pressures. The Troika’s divergence on the issue of fiscal austerity has perpetuated a crippling internal power struggle, which in turn has bred problems of policy confusion and questions of the Troika’s legitimacy, to the ultimate end of reduced efficiency and a slower, more painful European recovery. This research will use fiscal austerity, and the subsequent fiscal multiplier debate, as a microcosm for the underlying tensions of the Troika. Specifically, this paper will utilize a comparative analysis of the Troika bailouts in Greece and Ireland to highlight the Troika’s inherent friction over the issue of austerity, and the resulting policy inconsistencies. This analysis highlights how internal ideological, political, and structural constraints have produced “fatal flaws” for the Troika, which ultimately threaten the body’s future and assert the need for continued integration of the EMU. Favorito 2 Fiscal Austerity and the Fund: Examining Tensions within the Troika I. Introduction As the Eurozone crisis persists, the troubled national governments of Ireland, Greece, and Portugal have been cast as puppets in the economic and political drama of the Troika, with the body’s three members jostling over who pulls the policy strings. Faced with exceptional circumstances in 2010, as Greece, Ireland, and other heavily indebted, stagnant economies plunged deeper into sovereign debt crises, European authorities responded with the creation of a financial support mechanism, known as the “Troika,” which consists of representatives from the International Monetary Fund (IMF), the European Central Bank (ECB), and the European Commission (EC). Currently, the Troika, whose chief mandate is to coordinate joint programs of bilateral loans under strict conditionality, has facilitated bailouts for Greece, Ireland, Portugal, and Cyprus. However, this body has proven to be controversial, with politicians and academics alike criticizing the Troika’s internal politics, restrictive policy remedies of fiscal austerity, debt restructuring, and structural reforms, as well as its perceived incompetence. Fiscal austerity, a central component of the Troika’s policy prescriptions, has also been a bitter source of contention for both the program countries and the Troika members, as the ECB continues to vocalize its support for strict fiscal austerity, while the IMF has wavered and begun to promote slower consolidation. The general weakness of the Eurozone recovery and the visible tensions within the Troika raise questions about the body’s internal politics, such as how have the Troika members expressed differences of opinion on the topic of fiscal austerity? And, how have these nuanced differences played out in policy, and in particular, in the bailouts of Greece and Ireland? These questions ultimately speak to a larger issue: how do these tensions reflect the underlying Favorito 3 power relations among the IMF, EC, and ECB? Thus, the debate surrounding fiscal austerity can effectively serve as a litmus to understanding the complex, internal dynamics of the Troika. i. Hypothesis The Troika has been challenged both by internal discord surrounding controversial issues like the magnitude and pace of fiscal austerity, as well as by external political pressures. The Troika’s underlying ideological differences between the more conservative ECB and the more lenient IMF have given rise to pervasive inconsistencies and weaknesses within Troika policies, especially in relation to Greece’s bailout programs, effectively allowing policymakers to “scapegoat” the Troika for Europe’s troubles. The Troika’s divergence on the issue of fiscal austerity has perpetuated a crippling internal power struggle, which in turn has bred problems of policy confusion and questions of the Troika’s legitimacy, to the ultimate end of reduced efficiency and a slower, more painful European recovery. ii. Research Design In order to properly analyze the Troika’s internal dynamics using the contentious debate on fiscal austerity, this paper must first define the concept of fiscal consolidation. Fiscal austerity may take the form of expenditure-based policies, or reductions in government spending, revenue- based measures, such as raising taxes, or a combination both. However, this simple definition becomes complicated by reality, and specifically by fiscal tightening’s impact on growth and debt sustainability. Intrinsic to the discussion of fiscal austerity is the debate on the size of the fiscal multiplier, which measures the change in GDP that results from a change in tax and spending policy. While the Troika’s fiscal policies are predicated on the assumption that the fiscal multiplier is below 1, allowing for strict fiscal discipline like Greece’s “freezing of public Favorito 4 sector wages, partial cancellation of civil servant bonuses, and increases in indirect taxes,”1 this assumption has been increasingly contested, due in large part to Olivier Blanchard of the IMF’s work on the miscalculation of the Greek multiplier. This research will therefore use fiscal austerity, and the subsequent fiscal multiplier debate, as a microcosm for the underlying tensions of the Troika. Specifically, this paper will utilize a comparative analysis of the Troika programs in Greece and Ireland, as these two extreme cases highlight the Troika’s discord on the issue of austerity, and its resulting policy inconsistencies and varied levels of effectiveness. In addition, this analysis relies on an examination of the rhetoric employed by the IMF and ECB on the topic of fiscal austerity in working papers, speeches, and memos. Thus, the data encompasses both qualitative research, specifically economic and political rhetoric regarding fiscal reform, and quantitative analysis of the Eurozone crisis and the impact of the Troika programs. II. Background i. The “Troika” As the Eurozone plunged into unsustainable debt, unemployment, and despair in 2010, European authorities scrambled to form a crisis resolution mechanism, informally known as the “Troika.” Lacking a European bailout institution, the Euro Summit assembled the Troika task force in March 2010 to coordinate bilateral, conditional loans to Greece and to stop the spread of debt disease across Europe. Comprised of representatives from the IMF, ECB, and EC, the Troika is neither a “lending nor a decision-making institution,”2 but rather is a vehicle for evaluating, negotiating, and overseeing European bailouts. The fundamental purpose of the Troika is to negotiate and monitor financial assistance between recipient governments and 1 Greece: Ex Post Evaluation of Exceptional Access under the 2010 Stand-By Arrangement, country report no.13/156 (Washington, DC: International Monetary Fund, 2013), 7. 2 Jean Pisani-Ferry, André Sapir, and Guntram Wolff, EU-IMF Assistance to Euro-Area Countries: An Early Assessment, no. 19 (Brussels, Belgium: Bruegel Blueprint Series, 2013), 23. Favorito 5 official lenders, namely the IMF and the ESM (European Stability Mechanism). The Troika assembles economic adjustment programs that involve conditionality on three key fronts: “fiscal measures aimed at reducing public debts and deficits; financial measures to restore the health of the financial sector; and structural reforms to enhance competitiveness.”3 Currently, the Troika has provided substantial assistance to Greece, Ireland, Portugal, and Cyprus, managing two bailout programs in Greece, valued at €274.5 billion total, a €85 billion bailout in Ireland, a €78 billion bailout in Portugal, and €10 billion worth of funds in Cyprus.4 However, in December 2013, Ireland became the first country to exit its Troika bailout program, finishing “clean” without any further assistance or a precautionary credit line.5 The Troika’s institutional structure is complex, both in theory and in practice. While the IMF, ECB, and EC share responsibilities such as program negotiation and monitoring, they also each play a specific, individual role within the body, at least in theory. The IMF is the only Troika member with lending capabilities, and has provided roughly a third of the funding for the bailout programs in Greece, Ireland, and Portugal, while the other two-thirds comes from European partners.6 However, with the development of the ESM in 2012, much of the IMF’s lending responsibility has been transferred to this fledgling European institution. The EC acts as the “agent” of the Eurogroup within the Troika, negotiating on behalf of member states, which in turn provide the requisite funds to Troika programs. The EC must also protect the mandate of the Maastricht Treaty and other EU regulations in Troika policies.7 The ECB has a more ambiguous, undefined role within the Troika, which is formally stated as working “in liaison” with the 3 André