The Netherlands must stick to its austerity plan said, Klaas Knot, President of the Dutch Central Bank (DNB) Thursday at the presentation of the annual report of the Central Bank. The disappointing economic growth and rising unemployment are no reason to refrain from spending cuts and economic reforms.
Global economic growth in 2012 was below expectations. At the heart of this are unhealthy balance sheets of financial institutions, governments and households. The correction of imbalances, which vary from country to country, will take time. The present economic downturn is the price we are having to pay for growth enjoyed in the past, which in hindsight was not sustainable.
Still, there is definitely positive news as well. The past year saw the foundations being laid for a turn for the better in the euro area. Agreements were made to strengthen the monetary union for instance. The most far-reaching measure was the creation of a banking union that aims to break the negative feedback loop between national governments and banks that has manifested itself so vehemently in recent years.
The progress made by countries such as Ireland, Portugal and Spain in improving their competitive positions and trade balances is remarkable. 2012 was also the year in which the ECB introduced powerful policy instruments to underscore the irreversibility of the monetary union.
The slow-down in Dutch economic growth has been sharper than in neighbouring countries. Our economy is living proof that financial distortions in the past will take their toll sooner or later. The current poor growth rates find their origins to a large degree in the 1990s, when the economy expanded rapidly, thanks in part to home equity releases following a spectacular rise in house prices, the stock market boom and inadequate pension contributions. Now that house prices have gone down, pension contributions have gone up, and debt has to be reduced to manageable proportions, we are facing the downside: negative wealth and income effects that dampen consumption and economic activity.
The value of balanced financial developments, putting a check on excessive debt accumulation, can hardly be better illustrated. In this light, the housing agreement, which puts an end to, for instance, the current practice of maximising mortgage loans and minimising repayments, is an important step forward. Another vulnerability related to high mortgage debt is the dependency of banks on market funding, which has become increasingly difficult to obtain. Greater involvement of pension funds in mortgage funding is therefore welcome and could give the housing market a push in the right direction.
The Dutch economy may be faltering, but its fundamentals are sound as international comparisons show. Its competitive position is strong and the labour participation rate is still high. The reform of the labour market and the increase in the state retirement age that have been announced are necessary measures to maintain the Netherlands’ favourable starting position.
However, Dutch public finances are not yet in order. The budget deficit must be reduced to below 3% in 2014. Unlike many other countries in the euro area, the Netherlands still has a deficit if the interest payments are disregarded, i.e. the ‘primary balance’. Current expenditure also still exceeds current revenue. The fact that the total deficit is still relatively limited is due to the unprecedented low interest rates rather than to stringent control of expenditure. And it is obvious what will happen as soon as interest rates go up again. Another reason for additional action is the adverse trend in the structural budget balance, which adjusts for cyclical movements. If no additional measures are taken, this balance will deteriorate again next year, thus moving even further away from the target agreed in the Coalition Agreement.
Financial institutions are also facing hard times. That is an important reason why the international introduction of new regulatory frameworks, such as Basel III and Solvency II, has been postponed. A short delay in the introduction of the new rules is preferable, however, to diluting them. Nevertheless, the transition to the new regime must be set in motion in time. Our new supervisory approach is therefore designated to ensure that institutions anticipate the arrival of the new regimes as far as possible. The need to continue restoring buffers through cost cutting, wage moderation and profit retention is beyond dispute.
Finally, meaningful reforms have been undertaken, both in Europe as a whole and in the Netherlands, and financial vulnerabilities are being reduced. Implementing structural measures and reducing excessive debt positions are lengthy and painful processes. But they should not be a reason for watering down the reform measures as these are indispensable if we are to achieve financial stability, economic growth, and consequently sustainable prosperity.