How Austerity Is Increasingly Crushing Europe

Earlier this month, private equity behemoth KKR published its outlook for 2013. Among their theses was the expectation that global inflation remains low as Europe continues to delever.

Henry McVey of KKR wrote about austerity in Europe and noted how fiscal austerity in the form of deficit reduction was slamming GDP growth:

Fourth, the European fiscal multiplier is now larger than in the past, which we believe means below-consensus growth in the region again this year.

Having been to Europe multiple times in 2012 to assess the macro situation, it has become increasingly clear to me that “this time is different” when it comes to the relationship between fiscal contraction (the independent variable) and GDP growth (the dependent variable). Specifically, over the past twenty or so years, a one percent contraction in the fiscal deficit traditionally led to only about a 50 basis point contraction in GDP5. Today, by comparison, the multiplier in Europe is closer to 1.25-1.75x, we believe (Exhibit 20). As a result, aggressive monetary policy is less effective in offsetting current fiscal headwinds. As the exhibits above show, we link a significant portion of this relationship shift to excessively high bank leverage as well as some of the structural rigidities imposed by a common currency.

SEE ALSO: KKR's Outlook For The Markets And Economy In 2013 >