The monetary union will fail if it is run for the benefit of creditors alone
Why is conventional German thinking on macroeconomics so peculiar? And does it matter?
The answer to the second question is that it matters a great deal. A part of the answer to the first is that Germany is a creditor. The financial crisis has given it a dominant voice in eurozone affairs. This is a matter of might, not right. Creditors’ interests are important. But they are partial, not general, interests.
Recent complaints have focused on the European Central Bank’s monetary policies, especially negative interest rates and quantitative easing. Wolfgang Schäuble, Germany’s finance minister, even claimed that the ECB bore half of the responsibility for the rise of the Alternative for Germany, an anti-euro party. This is an extraordinary attack.
Criticism of ECB policies is wide-ranging: they make it unnecessary for recalcitrant members to reform; they have failed to reduce indebtedness; they undermine the solvency of insurance companies, pension funds and savings banks; they have barely kept inflation above zero; and they foment anger with the European project. In brief, ECB policy has become a big threat to stability.
All this accords with a conventional German view. As Peter Bofinger, an heretical member of Germany’s council of economic experts argues, the tradition goes back to Walter Eucken, the influential father of postwar ordoliberalism. In this approach, ideal macroeconomics has three elements: a balanced budget at (almost) all times; price stability (with an asymmetric preference for deflation); and price flexibility.
This is a reasonable approach for a small, open economy. It is workable for a larger country, such as Germany, with highly competitive tradeable industries. But it cannot be generalised to a continental economy, such as the eurozone. What works for Germany cannot work for an economy three times as large and far more closed to external trade.
Note that in the last quarter of 2015, real demand in the eurozone was 2 per cent lower than in the first quarter of 2008, while US demand was 10 per cent higher. This severe weakness in demand is missing from most of the German complaints. The ECB is rightly trying to prevent a spiral into deflation in an economy suffering from chronically weak demand. As Mario Draghi, ECB president, insists, the low interest rates set by the bank are not the problem. They are instead “the symptom” of insufficient investment demand.
The history of the German economy since its labour market reforms of the early 2000s demonstrates that “structural reform” is most unlikely to solve this problem. The most important macroeconomic fact about the country is that it is unable to absorb almost a third of its domestic savings at home, despite ultra-low interest rates. In 2000, before the reforms — which cut labour costs and workers’ incomes — German corporations invested substantially more than their retained earnings. The opposite is now true. With households in surplus and the government in balance, a vast external surplus has duly emerged. (See charts.)
Why should others be able to make productive use of savings Germans cannot apparently use? Why should structural reforms elsewhere, as advocated by Germany, generate the investment surge lacking at home? Why, not least, should one expect indebtedness to have fallen when demand and overall growth is so weak in the eurozone as a whole?
What has happened, instead, is the conversion of the eurozone into a weaker Germany. The current account balance of the eurozone is expected to shift towards surplus by close to 5 per cent of gross domestic product between 2008 and 2016. Every member is forecast to be in balance or surplus. The eurozone is dependent on the willingness of others to indulge in the spending and borrowing it now eschews.
Yet the rest of the world is cautious, too. The ECB has adopted negative real (and nominal) rates because additional savings are now worth so little. It has also learnt from the dire results of the rise in interest rates in 2011. The easing it has adopted since 2012 is at least bearing fruit in a meaningful, if inadequate, recovery: real demand has risen by 4 per cent since its nadir in the first quarter of 2013; and core inflation, albeit only about 1 per cent, has at last stabilised. This is not failure. It is success.
Inevitably, such policies are unpopular in creditor countries. But the argument that the threat is excessively loose monetary policy ignores the dangers posed by excessive tightening. It assumes that deflation would pose no problem. Yet it would raise real indebtedness, undermine the flexibility of real wages and even impair the effectiveness of monetary policy, since it would be far harder to generate negative real interest rates when needed. A deflationary spiral would be a much bigger threat than negative interest rates.
Above all, the eurozone will fail if it is run for the benefit of creditors alone. Policy must be balanced. The ECB’s determination to avoid deflation is an important part of that aim. Achieving better balanced demand at the national level is another. A huge deficiency of demand (relative to aggregate supply) in the eurozone’s biggest economy is highly problematic. The EU’s “excessive imbalance procedure” should be far more critical of Germany’s surpluses.
Germany’s ideas and interests are of huge importance to the eurozone. But they should not determine everything. If Germans believe this fatally weakens the legitimacy of the European project, they should use their exit option. To do so would also entail accepting great short-term disruption. But, so long as the country stays in the euro, it must also accept that the ECB has a job to do. If the latter does so, it will not make the eurozone work well. But it is surely a vital contribution to that end.
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