The curious austerity debate in Germany – OMFIF
Germany starts a conversation about its post-pandemic macroeconomic policy. It is a curious debate, with echoes of austerity which may appeal to a German public known for its conservatism, but which also goes against today’s economic realities.
With an election looming, German politicians and commentators are engaged in a back and forth over what to do in a post-Covid world and the now suspended constitutional debt brake, which limits the structural federal deficit to 0.35% of gross domestic product.
The debt brake has been put on hold given the pandemic-induced recession and will remain so until the end of 2022. But when a senior Angela Merkel aide suggested Germany might not be able to adhere to it for several years, Armin Laschet, chancellor of the Christian Democratic Union – candidate for the next elections in September, quickly retaliated, affirming that the debt brake must remain. Laschet may have tempered his views since then. But the Free Democratic Party did not. Even the Social Democratic Party (SPD) seems divided. Olaf Scholz, the SPD finance minister in Merkel’s grand coalition and her party’s candidate for chancellor, has suggested that Germany return to the debt brake as soon as possible. On the other hand, the Greens want a reform, allowing additional climate spending.
On the monetary policy front, the Bundesbank is making subtle rumors about reducing the European Central Bank’s emergency pandemic purchasing program. Bundesbank President Jens Weidmann said: “Emergency monetary policy measures must not be allowed to go on indefinitely. They must remain closely linked to the crisis and end once the pandemic is over ”.
Why does this debate seem curious on the American side of the Atlantic?
Germany and Europe still face considerable negative output gaps. Ending the debt brake prematurely could hurt the recovery.
The combination of German “schwarze Null” fiscal policy and the debt brake has long been viewed as a restrictive financial straitjacket, given infrastructure and investment needs and deflationary impulses.
Scholz’s finance ministry calls for greater flexibility and abandons schwarze Null. Indeed, given the role of the SPD within the Ministry of Finance, it is ironic to see key party figures joining the CDU / FDP side of the debate.
The 60% Maastricht debt target, long touted by Germany, was developed at a time of significantly positive real interest rates. But today, rates are negative in nominal and real terms. Past views on debt sustainability are widely seen as overly restrictive and ill-suited.
The debate contrasts with the larger European discussion on overhauling the European Union’s fiscal rules, which are universally seen as archaic and confusing. It also apparently contradicts the thrust of the International Monetary Fund board not to withdraw political support prematurely.
Meanwhile, the case for an early reduction in PEPP also looks dubious. Monetary policy must reflect the state of the entire euro area, not just part of it. The economic slack remains clear. Europe has long exceeded its inflation target. Even if prices climb 4% year-on-year in the coming months, the ECB has made it clear that this will only reflect temporary developments. The ECB also said financial conditions should remain accommodative. Asset purchases are a key part of this. In addition, the ECB is about to complete its strategic review, which is expected to include conclusions on asset purchases.
Germany is looking at tighter fiscal and monetary policies is a potential recipe for austerity. It is not certain that this is in the interest of the German economy. It could rekindle deflationary spillovers across the euro area, just as Germany’s macroeconomic policies have done throughout the past decade.
How bad this would be for the German economy is another question. Germany has long accumulated huge current account surpluses, absorbing demand from the rest of the world. The IMF predicts that Germany’s surplus of 7% of GDP will barely budge over the next five years, while easily exceeding $ 300 billion a year.
Germany knows that with the rapid growth of the United States and China, it can support growth by drawing on the rest of the world through its export-oriented model. But just as this strategy sparked massive criticism less than a decade ago, its renewal may well spark international objections again.
Restoring the debt brake prematurely and moving to a less accommodating monetary policy is not the way forward for Germany, Europe or the international community.
Mark Sobel is US President of OMFIF.
Further reading: David Marsh: Bundesbank pushes ECB asset purchase plans