I would hate to be in government right now

The final months of last year were dominated by escalating and justifiable concerns about the euro’s viability.

These concerns diminished early this year as observers and the markets were relieved by the response of European policymakers and by the ECB’s long-term refinancing operation.

This involved the ECB granting three-year loans to European banks in order to provide them with enough capital to remain operational. Rather than being loaned to customers, most of this money was used to buy government bonds.

This meant the banks improved their balance sheets and bought the bonds, which are a less risky asset than lending money in the difficult economic environment across the eurozone.

Unfortunately, this operation did not find its way into the real economy. Even more unfortunate is the fact that the eurozone crisis has returned to the top of the agenda due to the simple fact that the economic background in much of the eurozone is now dire.

A quick perusal of some recent eurozone economic and political developments does not make for pleasant reading. The Spanish economy went back into technical recession in the first quarter; its unemployment rate stands at 23.6% of the labour force with youth unemployment above 50%; and despite the savage austerity under way, it missed its budget deficit targets last year and will likely do so again this year. Italy is not too far behind Spain.

In the Netherlands the government has fallen over the failure to agree measures to bring its budget deficit below 3% of GDP by next year. In France the first round of the presidential election saw victory go to the socialist, François Hollande, who is seeking to add a growth pledge to the EU fiscal treaty. The far-right candidate Marine Le Pen performed strongly on a platform of ultimately taking France out of the euro.

Taken in isolation any one of these developments is not good news for those who want to see the eurozone survive in its current form, but taken together it makes a worrying back drop for Europe. The lack of economic growth, which is what economic policy should be largely all about in the first place, is generating a considerable backlash against the austerity that is being primarily driven by Germany and its allies in the ECB.

From a German perspective it is not hard to understand where it is coming from. In the main, Germany has behaved in a pretty fiscally prudent manner in recent years. Many Germans are not overly enamoured with the notion of irresponsible countries in the eurozone not delivering on austerity and continuing to behave in what they would see as an imprudent manner.

Against this background, the future stability and indeed survival of the euro is now centre stage again. The key point is that if those countries with unsustainable debt levels are forced to continue to pursue policies of fiscal austerity, growth prospects will only get worse in the absence of the option to accompany the fiscal austerity with a sharp decline in the nominal exchange rate. This latter option is not possible within the euro structure.

All of this adds up to one very confused debate about fiscal austerity. Ireland’s government debt stood at just over €169bn at the end of 2011, equivalent to 108% of GDP and it is still rising. Debt servicing costs reached €5.3bn last year and this will rise further.

Growth is required to stabilise the debt, but this will be hard to generate without a functioning banking system and against a background of savage austerity. In the absence of a fall in the value of the nominal Irish exchange rate, which is not possible as long as Ireland is in the euro, or external debt forgiveness, it is hard to see how this conundrum can be sorted out. I would hate to be in government. The eurozone is in one hell of a crisis.