Convergence: 1960-2008
Aaron Bady on the Insanity of Nino Scalia

Martin Wolf: What Should Spain Have Done in the Mid-2000s?

Martin Wolf:

What was Spain supposed to have done?: In January 2004, I attended a property conference in Switzerland….I argued that a number of European countries, the UK being one, had dangerous property booms. The most dangerous of all, I suggested, was Spain’s…. This remark led to a heated altercation with a Spanish property developer. I understood why he was so angry. But he was wrong, of course. The Spanish property sector created a huge boom and a huge crash. The big question is what the Spanish authorities should (or could) have done about it.

One answer is that they should have tightened fiscal policy, since they could do nothing about the monetary policy of the eurozone, which was wildly unsuitable for their economy, prior to the crisis (far too loose then and far too tight now). Maybe so, but Spain’s fiscal performance looked pretty good…. In 2008, the IMF, among the world’s most independent and respected official institutions, thought that Spain had run a substantial structural – or cyclically-adjusted – fiscal surplus in 2004, 2005, 2006 and 2007. Now it thinks this had in fact been a substantial structural deficit…. [T]here was no obvious reason why Spain should have run a tighter fiscal position before the crisis. It had an official seal of approval for what it was doing. In a boom, just about everybody misunderstands what is happening.Those who do not are Cassandras and so tend to be ignored….

What else could the Spanish authorities have done? Well, they could have tried to curb bank lending directly, via rapidly falling loan-to-value ratios or direct curbs on lending. There are two reasons for wondering whether this would have worked. First, it would have been desperately unpopular in Spain…. Alternatively, they could have tried to make their banks more robust. But they did in fact try to do so, with their famous policy of dynamic provisioning. It was controversial at the time, though a good idea. The problem, as we can now see, is that it was nothing like enough….

Spain did not run irresponsible fiscal policies, as Germans believe….

[H]ow could Spain have prevented this crisis, which was unambiguously generated in the domestic private sector and fuelled by private sector capital inflows? If it could not have prevented the crisis, how can it bear some deep moral fault? Surely, a far more sensible – indeed moral – approach would be to recognise that this is more misfortune than misdeed and offer Spain the help it needs to adjust its economy to the post-crisis reality….

In my view, Spain made only one big mistake: joining the euro. Without that, it would probably now look more like the UK: yes, the economy would be in serious trouble, but its exchange rate and its long-term interest rates would both be far lower. After all, its fiscal position is even now no worse than the UK’s, as I note in my blog post here. But reconsidering that choice is no longer possible. Now it needs help to survive the crisis. Will Spain get enough of what it needs? I doubt it.