In 2012 The IMF studied the correlation between credit-default-swap spreads and various economic indicators. Long term indicators—for deficits, economic growth and spending on pensions and health care—had little impact on spreads. But larger short term primary deficits (which exclude interest) were associated with notably wider spreads. So, too, was weaker current-year growth.
Solvency should be a function of longer-term growth and fiscal trends, but markets instead seem to care more about the short term. Tighter fiscal policy, by hurting the near-term growth outlook, could actually lead to wider, rather than narrower, spreads. Cut the deficit too aggressively, in other words, and the negative impact on growth and the rise in the cost of debt service from higher spreads could result in a higher, not lower, debt-to-GDP ratio.
In addition to debt levels and deficits, the growth performance of countries is closely monitored by financial market participants. Depending on how austerity measures impact output growth, yield spreads may rise or fall in response to austerity. Markets can become “schizophrenic” about austerity in that they demand austerity measures as public debt builds up, but fail to reward them, as austerity slows down output growth.
How has the 2008 financial crisis impacted our COVID19 world? The first clear effect is that states that pursued austerity politics and underfunded or privatized public health facilities find themselves unable to adequately deal with the burden caused by the pandemic. Austerity threw greater numbers of people into poverty. In the United States, the unviability of employer-based health care provision is exposed when mass unemployment meets global pandemic.
As we continue amidst the fallout of the COVID-19 pandemic, now is not the time for austerity. Investing in workers and public services, providing safe working conditions, ensure seniors are properly cared for, and renew a health care system to withstand any challenges that may arise. Unfortunately, taxation is the means by which governments will bring down the deficits. Expect the middle class to be squeezed even more.