Posted by: Dirk | April 19, 2012

Boomtje Boomtje, Bustje Bustje

The Telegraph has written yesterday about the coming economic problems of the Netherlands (look at the text, not the picture):

“The Dutch are on the edge of a negative rating action,” said Chris Pryce, Fitch’s expert on the Netherlands. The first move is likely to be a switch from stable to negative outlook rather than a full downgrade.

“We will hold a rating committee meeting in June. They run risks if they keep letting debt rise: a cautious approach would be advisable,” he told the Telegraph.

The warning comes as Dutch property tips into deeper slump, with the inventory of unsold homes nearing South European levels. Household debt is the eurozone’s highest at 249pc of income, compared with 202pc in Ireland, 149pc in the UK, 124pc in Spain, 90pc in Germany, 78pc in France and 66pc in Italy – according to Eurostat data from 2010.

The Netherlands is caught in a “negative feedback-loop” as recession and house price falls feed on each other. Building permits have dropped 9pc from a year ago, the lowest since 1953. “The housing market is in a coma,” said the Volkskrant newspaper.

I had reported domestic credit/GDP levels for some European economies earlier this year in this post. You can see clearly that Dutch levels of domestic credit are right there with Spain’s, Ireland’s and Portugal’s. So, I would expect the Netherlands to enter the abyss when I read this:

Premier Mark Rutte is struggling to put together an austerity package before a deadline this week but he relies on support from populist leader Geert Wilders, who has threatened walk out of talks. His Freedom Party calls for a return to the guilder.

Well, now the solution to every economic problem is: austerity. Too much government debt? Austerity! House price bubble collapses? Austerity! Low growth? Austerity! The solution of Mr Wilders is premature, although in theory it would work. However, as long as unemployment is suppressed, it doesn’t make any sense for the Netherlands to leave the euro, especially since it is a “supertrader“: (exports+imports)/GDP>100% (well, almost).

Historical evidence says that austerity doesn’t work, and to my knowledge there is no theory that supports it either. You can, of course, use neo-classical theory, but that is about flows, not stocks. You simply cannot jump to the conclusion that if you stop a flow (government expenditure) the stock (government debt) will change in the very same direction by the very same amount. For a single household, that may work: I save €100 a month more in order to repay my debt of €1,000, and after 10 months it is all over. However, if all households do it at the same time, then the increase in savings will cause a significant contraction in demand. Hence, firms will not be able to sell and not hire or fire workers. That will make the demand problem worse, since now these newly unemployed consume even less. The government income (taxes) will sink and expenditures will rise (unemployment insurance). There is no one-to-one relationship between the flow and the change in the stock!

The neo-classical theory is a strict flow theory and cannot deal with levels debt. In neo-classical theory, households (entrepreneurs) can only borrow from other households, so that aggregate household debt is zero and non-relevant. However, that is not what reality looks like. Households as an aggregate are indebted, and very much so. Also, some households might face bankruptcy problems. Using neo-classical theory in a situation where debt levels play a major role will lead to wrong policy prescriptions, like austerity. It is the same with some policy prescriptions of Keynesian theory in a situation of full employment, where debt levels might not be binding and a liquidity trap is nowhere in sight. When ideology rules, economies break.



  1. Nice blog entry again, Dirk. Do you have a pointer to any serious statistics on house prices? A quick search at least yielded this article:
    Don’t miss the comments.

  2. – don’t miss the comments.

  3. […] lending to invest in property has produced a real estate bubble just like in Ireland or Spain. I wrote about this in April and apparently the information coming in these days seems to vindicate my writings. Here is […]

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