A shift in German policy? Not so fast! The ECB didn’t take any action at its governing council meeting this past Thursday, but that does not mean nothing happened. ECB president Mario Draghi gave the clearest signal yet that the central bank is co...
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A shift in German policy? Not so fast!
The ECB didn’t take any action at its governing council meeting this past Thursday, but that does not mean nothing happened. ECB president Mario Draghi gave the clearest signal yet that the central bank is committed to using unconventional policies—including controversial quantitative easing (QE)—to address low inflation in the eurozone.
This is the first time the ECB has ever admitted to having serious discussions about QE. Draghi’s comments came off the back of an admission by the biggest opponent to QE—head of the German Bundesbank, Jens Weidmann—that such a policy might be necessary.
Weidmann’s admission flies in the face of German monetary orthodoxy. It is practically in the German DNA to be allergic to anything that might risk stoking hyperinflation. With Eurozone inflation decelerating to 0.5%–compared with a target of just under 2%–in March, hyperinflation is hardly a concern.
Some have hailed these recent developments as a fundamental shift in the German approach to the eurozone crisis. But they are misreading the signs. While QE by the ECB is more likely today than it was a year ago, Weidmann’s comments were merely an attempt to shift investor expectations so the overvalued euro might weaken.
Macro Approach More of the Same
More importantly, Germany’s macroeconomic approach to the eurozone crisis has not shifted at all. This approach was recently summarized by Otmar Issing, the former chief economist of the ECB, in a March 25th op-ed in the Financial Times entitled “Get your finances in order and stop blaming Germany.” In line with the Berlin View, Issing ignores Germany’s role in causing and perpetuating the crisis.
Having misdiagnosed the problems in Europe, the German government continues to support the wrong remedies to address the crisis and in doing so is condemning the eurozone to years of chronically weak growth.
The main cause of the eurozone crisis according to Berlin was that countries did not follow the rules, and consequently saw their public finances, competitiveness and banking sectors deteriorate. The blame for this lies entirely with the weaker countries. As Issing put it, “The countries now in trouble have caused their own problems through their own policy mistakes”.
The remedy, according to this logic, is for the peripheral countries in Europe to push through austerity measures and structural reforms to get their fiscal houses in order and recover competitiveness. The stronger countries make no adjustments, but extend loans to their weaker neighbours to give them time to make these painful reforms. In the meantime, all countries using the euro sign up to new eurozone governance rules—the two pack, six pack and fiscal compact—to make sure the rules are clear and followed by everyone.
It’s Balance of Payments, Stupid!
If you support the German government’s view of the eurozone crisis, you will have been nodding in agreement up to this point. But you would be wrong to do so. The German government has only considered those causes of the crisis that are convenient for it to consider. This crisis was not just caused by policy mistakes in the weaker countries—its roots lie in policy mistakes in Germany too.
German economic policy in the 1990’s suppressed wage growth and forced up German national savings. These savings were exported to other eurozone countries, which used the funds to buy German goods and services. Germany became addicted to exports of goods and services for economic growth, and its current account surplus soared.
Tied to the euro, the weaker countries in Europe could not use interest rates or currency depreciation to prevent Germany from exporting its excess savings to them. Instead they had to balance the excess of German savings over investment with higher investment and lower savings themselves.
Capital flooded into the Irish and Spanish property market, the Greek sovereign bond market and the Portuguese retail sector. These bubbles weren’t only the result of corruption, waste and laziness in the periphery, as the German government sometimes argues. They were the result of Germany’s persistently high savings and low domestic investment as well. This is simply how balance of payments works.
Going for a Win-Win
Not only has this been bad for the periphery once the bubbles burst. It has been bad for Germany as well. According to a study by the German Institute for Economic Research (DIW) in Germany, German investors have lost around 600 billion euros on their foreign assets between 2006 and 2012. In exporting German national savings abroad, Germany has made some terrible investment decisions—particularly in the US sub-prime market, the Irish housing market and Greek sovereign debt market—and has been forced to accept huge losses.
On top of this, Germany has suffered from a lack of investment at home. According to DIW, had the rate of investment in Germany been in line with the euro area average since 1999, growth in German GDP per capita would have been one percent higher annually.
The German government’s solution to the eurozone crisis so far has been for the weaker countries to adjust severely, pushing down wage and pension growth to regain competitiveness vis-à-vis Germany. This forces national savings up in the periphery. If all countries in the eurozone have high national savings, economic growth will slow to a crawl at best.
Instead, Germany should implement policies to push down its national savings and promote domestic investment. Not only would this help unwind imbalances within the eurozone, but it would give Germany’s economy a boost as well. It would be a win-win.
The German government would no doubt respond to this suggestion by insisting that Germany is already doing this by introducing a minimum wage and allowing wages to rise more quickly over the past few years. This is true, but Germany’s adjustment has not gone nearly far enough, and has been tiny compared to the periphery’s swingeing adjustment.
The German government would argue that a more symmetrical adjustment would take the pressure off of weaker countries to reform, and they would not implement unpopular measures. But moral hazard cuts both ways. Germany and other core countries are at least as much to blame for structural distortions and imbalances within the eurozone as are the weaker countries. As long as this is denied rather than addressed, the best case scenario for the eurozone is a Japanese-style lost decade of very sluggish growth.
This piece originally appeared in the April 6th edition of the Sunday Business Post.