German Chancellor Angela Merkel's government has taken a peculiarly aggressive line in attacking budget deficits and loose monetary policy worldwide and repudiating them at home. But, while that stance resonates deeply with German voters, it makes no sense economically, particularly given Germany's commitment to European integration.
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.
The most obvious explanation for the German peculiarity is an obsession with the lessons of German history, particularly the two episodes of runaway inflation in the twentieth century, in which holders of monetary assets were expropriated. The Great Inflation of the early 1920’s, which culminated in a hyper-inflation in which prices changed several times daily, destroyed the middle classes and bred the political instability that eventually opened the way to Hitler’s rise. Hitler repeatedly promised that he would use any means to fight inflation, but his militarism also led to the expropriation of savings.
Even though only quite old people have personally experienced even the second of these episodes of monetary destruction, their political resonance is still acute. Germany’s mass circulation Bild Zeitung warned in a headline in March 2009 of inflation at a time when all price signals pointed in the opposite direction. Merkel has acute political antennae, and her response struck a deep chord with popular sentiment.
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A second rationale for Germany’s policy is demographic. Budget limitation appeals not just to the old, but is especially attractive to young people, who worry that they will be made to pay the costs of caring for an increasingly elderly and dependent population.
There is a third explanation for Germany’s particular stance. With governments around the world (including Germany’s) accumulating unprecedented levels of peacetime debt, markets are worrying about sustainability. Some crisis-prone countries such as Latvia are already unable to sell any more debt. But even large and stable countries such as Britain and the US are finding auctions of government paper increasingly problematic. Big investors, particularly Asian countries’ reserve funds, are increasingly nervous.
A cast-iron mechanism to ensure that the debt build-up does not continue forever is appealing as a way of withstanding increasingly fraught competition for funding. Germany will look like a better credit risk, thereby allowing it to fund its current budget deficits more easily and cheaply.
There is obviously some element of bluff in legislating balanced budgets. Extravagant promises to behave better at some future point are not completely credible, although they often have a short-term impact. In 1985, the US Congress passed the Gramm-Rudman Act, which provided for automatic spending cuts in the case of deficits. It was ruled unconstitutional, but it began a process of budget consolidation.
The European Union’s Maastricht criteria, which cap deficits at 3% of GDP, belong in the same category: a measure that could be relaxed as the political pressure changed, but which did help initially in reducing deficits and borrowing costs.
The real problem with the German measure is not so much our lack of knowledge about what the world will look like in 2016 or 2020 as it is that Germany is politically and economically bound to European integration, and thus tied to states with very different budgetary perspectives and priorities. As a result, it makes little sense for Germany to compete to have more solid budgets than its neighbors: all European countries have tied themselves together. When Germans tie their hands with constitutional budget laws, they are in effect untying their neighbors’.
Europe’s monetary unification of the 1990’s was supposed to be accompanied by fiscal convergence and harmonization. When budgets move in different directions, pressures shift to regional policy (to redistribute income) and to monetary policy (to boost growth). The prospects for friction between EU members escalate. The best hope for Germany is that people – both German voters and Chinese fund managers – will take such promises seriously now, but forget about them in ten years.
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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.
The most obvious explanation for the German peculiarity is an obsession with the lessons of German history, particularly the two episodes of runaway inflation in the twentieth century, in which holders of monetary assets were expropriated. The Great Inflation of the early 1920’s, which culminated in a hyper-inflation in which prices changed several times daily, destroyed the middle classes and bred the political instability that eventually opened the way to Hitler’s rise. Hitler repeatedly promised that he would use any means to fight inflation, but his militarism also led to the expropriation of savings.
Even though only quite old people have personally experienced even the second of these episodes of monetary destruction, their political resonance is still acute. Germany’s mass circulation Bild Zeitung warned in a headline in March 2009 of inflation at a time when all price signals pointed in the opposite direction. Merkel has acute political antennae, and her response struck a deep chord with popular sentiment.
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Access every new PS commentary, our entire On Point suite of subscriber-exclusive content – including Longer Reads, Insider Interviews, Big Picture/Big Question, and Say More – and the full PS archive.
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A second rationale for Germany’s policy is demographic. Budget limitation appeals not just to the old, but is especially attractive to young people, who worry that they will be made to pay the costs of caring for an increasingly elderly and dependent population.
There is a third explanation for Germany’s particular stance. With governments around the world (including Germany’s) accumulating unprecedented levels of peacetime debt, markets are worrying about sustainability. Some crisis-prone countries such as Latvia are already unable to sell any more debt. But even large and stable countries such as Britain and the US are finding auctions of government paper increasingly problematic. Big investors, particularly Asian countries’ reserve funds, are increasingly nervous.
A cast-iron mechanism to ensure that the debt build-up does not continue forever is appealing as a way of withstanding increasingly fraught competition for funding. Germany will look like a better credit risk, thereby allowing it to fund its current budget deficits more easily and cheaply.
There is obviously some element of bluff in legislating balanced budgets. Extravagant promises to behave better at some future point are not completely credible, although they often have a short-term impact. In 1985, the US Congress passed the Gramm-Rudman Act, which provided for automatic spending cuts in the case of deficits. It was ruled unconstitutional, but it began a process of budget consolidation.
The European Union’s Maastricht criteria, which cap deficits at 3% of GDP, belong in the same category: a measure that could be relaxed as the political pressure changed, but which did help initially in reducing deficits and borrowing costs.
The real problem with the German measure is not so much our lack of knowledge about what the world will look like in 2016 or 2020 as it is that Germany is politically and economically bound to European integration, and thus tied to states with very different budgetary perspectives and priorities. As a result, it makes little sense for Germany to compete to have more solid budgets than its neighbors: all European countries have tied themselves together. When Germans tie their hands with constitutional budget laws, they are in effect untying their neighbors’.
Europe’s monetary unification of the 1990’s was supposed to be accompanied by fiscal convergence and harmonization. When budgets move in different directions, pressures shift to regional policy (to redistribute income) and to monetary policy (to boost growth). The prospects for friction between EU members escalate. The best hope for Germany is that people – both German voters and Chinese fund managers – will take such promises seriously now, but forget about them in ten years.