Germany’s Fiscal Follies

PRINCETON – All over the world, public-sector deficits are exploding. Governments face massive costs rescuing banks and businesses hit by the financial and economic crisis.  There is a universal consensus that Keynesian stimulus is needed. At the same time, policymakers are looking more and more nervously for an “exit strategy.” They know that they cannot run deficits forever, but they do not want to say when the painful exit should begin.

Germany is different, not because it is not spending now, but in how it talks about the future. The German government has taken a peculiarly aggressive line in attacking deficits and in trying to lay down a firm exit strategy. Chancellor Angela Merkel has criticized the United States Federal Reserve and the Bank of England for “quantitative easing,” which has in practice allowed the central bank to monetize many types of government and non-government debt. The German government also successfully passed a constitutional law requiring the government deficit to be capped at 0.35% of GDP in 2016 and eliminated by 2020.

Both the attacks on excessively easy central banks and the effort to limit government debt are enormously popular in Germany. But they have been widely condemned by economists worldwide (including in Germany) as nonsense.

Merkel is not the first German politician to adopt a hardline stance on monetary policy and debt – nor is she the first to face a torrent of international criticism. In the late 1970’s, when the world was facing a mixture of stagnant growth and inflation, Chancellor Helmut Schmidt insistently told British, French, and American leaders that their deficits were wrong and dangerous. He believed that the solution to stagflation “was that those with deficits should get rid of them.” His fellow leaders began to think Schmidt arrogant.