Europe’s German Ball and Chain

BRUSSELS – A storm-tossed ship near dangerous cliffs needs a strong anchor to avoid finishing on the rocks. In 2012, when a financial storm engulfed the eurozone, it was Germany that kept the European ship off the shoals of financial disaster. But now Europe’s anchor has become a brake, hindering forward movement.

Of course, German Chancellor Angela Merkel acted in 2012 only when she could tell her domestic constituency that there was no alternative. But in the end, Merkel agreed to a permanent bailout fund for the eurozone. She also backed the formation of a banking union, which remains incomplete but still represents a key step toward a financial system supervised by the European Central Bank. Thanks to these measures, and ECB President Mario Draghi’s vow, which Germany tacitly approved, to do “whatever it takes” to save the euro, the financial storm abated.

But now the eurozone seems incapable of escaping near-deflation, with little economic growth and prices barely moving upwards.

That was not supposed to happen. When the crisis struck, the economies of the eurozone periphery were buffeted by the twin shocks of spiking risk premiums and a collapsing housing market. At the same time, the German economy benefited from the return of capital fleeing the periphery. Real (inflation-adjusted) interest rates in Germany became substantially negative, triggering a housing boom. It was assumed that this would generate strong domestic demand in Germany, helping the periphery to export more.