BlogSpot - November 10th, 2014
Germany’s central role in the eurozone crisis and recovery
With risks of deflation (see the latest Eurostat numbers), in a context of deleveraging and low growth, the Eurozone needs extensive (fiscal and monetary) policy actions to boost demand. With a focus on discipline and structural reforms, Germany is increasingly isolated in this debate.
The German economy may appear like a pillar of stability and performance in the Eurozone—accounting for about ⅓ of the eurozone’s GDP, having closed its output gap, experiencing low unemployment, and running a primary balance surplus, as noted by Edward Hugh. He also points out that the country’s competitiveness is due to labour productivity rather than low wages.
Yet, the export-led German growth strategy is reaching its limits. For Simon Tilford, the German growth model remains chronically export-dependent, reflected by a current account surplus over 7 percent of GDP. Adair Turner, in Project Syndicate, turns around on the German their praise for frugality and makes the point that German expansion has been fueled by credit expansion—to the rest of the world: generating current account surpluses and providing financing to deficit countries allowed China and Germany to enjoy export-led expansion. For Turner, the end of Germany’s credit-fueled expansion is forcing economies to increased fiscal deficits, permanently financed by central-bank money, to stimulate growth and increase inflation without generating higher private or public leverage.
The fiscal stance is not supportive of domestic demand. EuroIntelligence points out that recently announced measures on the fiscal front, i.e., a stimulus planned for 2016-18, amount for barely 0.1 percent of GDP. Simon Wren Lewis (hat-tip EuroIntelligence) rejects two argument usually given in favor of more active German policies in the eurozone—the fact that the country has more fiscal space and the idea that it would serve the regional economy. He argues that the former legitimize fiscal rules, which should not be followed when faced with a liquidity trap; and that the second forgets that fiscal expansion would actually benefit Germany.
As discussed in last week’s Warning Signals BlogSpot, Germany’s ambiguous stance against monetary expansion may be a constraint to policy making in the monetary union. For Paul de Grauwe (Free Exchange), the ECB’s insufficient policies are reflected in the expansion of the Fed’s balance sheet in stark contrast with the contraction of the ECB’s. Quantitative easing could an ultimate resource, as argued by Andrea Ferrero in Free Exchange. Ashoka Mody and Gina Gonipath (in Project Syndicate) further support proactive policy stances with central banks adjusting inflation targets as needed and intervening decisively.
Those, like Mike Peacok (Reuters), who stress the limits of ECB instruments (the TLTRO program and asset purchases) adopt an alternative approach focused on investment spending, also at odds with the current German stance. Population aging is a rationale for generating savings but the level of public investment is very low, driven in part by negative net public investment (i.e., insufficient to replenish the country’s public capital stock), as highlighted by Simon Wren-Levis. One solution he advances is for Germany to boost defence spending, from its current low of 1.3% of GDP, with the added bonus of contributing to Europe’s security. Cuts in incomes taxes and/or value added taxes could also help rebalancing the economy towards domestic consumption and shake off the impact of weaker exports. A second solution, he claims for the European countries is a period of above target inflation.
Simon Wren-Lewis (again, hat-tip EuroIntelligence) insists in another article on the role of Germany’s economic policy leading up to the crisis, suggesting that German disinflation before 2008 laid the ground for the crisis. He sees one exit from German’s real exchange undervaluation: faster relative inflation, to happen through two potential channel: faster growth/a boom in Germany, or lasting depression in the rest of the eurozone. He criticizes the focus on structural reforms “outside” of Germany as masking the real cause of the problem.
Agnes Benassy-Quere and Guntram Wolff, in a Bruegel article, suggest that the increasing divergent performances of Germany and France highlight the benefits and need for coordinated policymaking. The two countries have diverged significantly in terms on unit labor costs, current account balances, and export share—with France not compensating for rising costs by higher non-price competitiveness while low-cost Germany has become increasingly dependent on foreign markets. For the authors, getting out of the current economic impasse requires simultaneous implementation of measures in both countries.
EU growth: fiscal consolidation and public investment
With repeated downward revisions to EU forecasts, as reported by Philippe Gudin, the new forecasts are for a 1.3 percent GDP growth this year and 1.5 percent next year for the European union and 0.8 percent in 2014 and 1.1 percent in 2015 for the euro area. Outlook revisions (EU forecasts) raise issues concerning the respect of the Stability and Growth Pact requirements. The new EC forecasts singles out France as the weakest performer with below average economic growth, falling investment and deteriorating public finances and competitiveness (Reuters). In a VoxEU article, Philippe Martin and Thomas Philippon look back at the euro area crisis using a quantitative framework and find that a combination of fiscal and macroprudential policies is required to lift the euro area into a sustainable recovery.
Boosting investment through public spending is on the European agenda (Reuters). Lack of demand may have been compounded by the emphasis put on inflation targets and debt reduction as argued by Simon Wren-Lewis in Mainly Macro. Jean Pisani-Ferry, in Project Syndicate, considers three different investment levers to start a more efficient recovery: budgetary, regulatory and financial. On the last two fronts, he calls for reforms that will promote predictability and higher risk taking by banks through respectively prices outlook, a European framework for projects and shared risks initiatives during a small period. He completes this analysis in a VoxEu article, where he prompts changes in legislation to promote sustainable investment in equipment as substitutes of inefficient assets. This could be made for instance through a more constraining emission standards.
Going further, Guiso and Morelli (VoxEU) evoke the creation of a “European Federal Institute” (EFI) dealing with both short-run recovery measures and the implementation of a federal budget. This would take place in a two-step scheme: first, the federal institute would issue bonds bought by the ECB and then the institute would be able to lend to the countries an equal amount enabling them to cut taxes or invest. Wolfgang Münchau, in a Spiegel column, discussed this transferred sovereignty project with similar objectives of European Commission’s bonds purchases.
Beyond investment, demand could be supported by increasing the share of wages in GDP and reducing inequality. Goodhart & Erfurth (VoxEU) propose measures, involving government intervention, to raise the share of equity finance in housing markets. Similar measures could be taken in other sectors of the economy, helping sustain domestic consumption. The tool is a Shared Responsibility Mortgage (SRM), in which the lender gives a protection to the borrower on the downside in exchange for a share of the upside capital gain. Such instrument would have the added benefit of countercyclical automatic stabilization.
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