The New York Times and the Financial Times have criticised Germany’s reluctance to adopt an expansionary fiscal policy in the face of a weakening global economy. With the effectiveness of monetary policy in doubt, they argue that fiscal policy is even more than important than ever to counteract what appears to be an intensifying economic downturn that risks morphing into prolonged (secular) stagnation and deflation. Given that Germany is not only the largest economy in the euro area, but also the economy with the largest fiscal space, international commentators find it difficult to understand Berlin’s reluctance to go for a fiscal stimulus. They find this even more incomprehensible in light of the fact that the export-oriented German economy appears to have been more affected by weakening global economic conditions than other large economies. The German economy seems poised to tip into recession.
Germany has historically been more reluctant than many other countries to resort to counter-cyclical fiscal policies (aka Keynesian demand management). During the euro area crisis, Germany resisted expansionary fiscal policies that would have helped provide a much-needed stimulus to the peripheral euro area economies. This effectively increased the adjustment burden on the peripheral crisis economies. In the terminology of Charles Kindleberger (1973), Germany acted as a ‘lender-of-last-resort’ by offering financial support. But it did far less to "open markets to the distressed countries" in the sense of generating additional demand for the peripheral economy exports than it could have done. Germany deflected the burden of macroeconomic adjustment and stuck to its macroeconomic policy preferences.
Compared to other countries, Keynesianism’s popularity in Germany was short-lived. In the late 1960s and early 1970s, the German government under the leadership of Finance Minister Karl Schiller resorted, to but quickly abandoned a demand management oriented fiscal policy (so-called Globalsteuerung). The Keynesian experiment came to an end with the first oil shock and economic stagflation. This experience has contributed to Keynesianism’s lack of popularity ever since. Besides the historical experience, there is perhaps also an economic argument that limits the popularity of Keynesian policies. In an export-oriented, open economy with an independent central bank, fiscal stimuli tend to be less effective than in less open economies where the central bank acts in a more accommodating manner (Scharpf [1987] 1991). Admittedly, lack of monetary accommodation is probably not something the German government should be worrying too much about at the present moment.
Financially speaking, Germany can certainly afford a limited fiscal stimulus - and certainly a time-limited one. At less than 60% of GDP, Germany’s government debt burden is low by international standards. The ratio compares very favourably to the US (106%), the UK (87%), France (99%), not to mention Japan (237%). Unlike in the other major economies, it has also been on a downward trajectory since after the global financial crisis thanks to a small fiscal deficit and decent economic growth. Gross government debt fell from 81% of GDP in 2010 to just below 60% of GDP in 2018 and it is set to fall below 50% of GDP by 2022. Few, if any, of the other major economies are projected to see their debt ratios decline in the medium term. If that weren’t enough, Germany has also one of the lowest interest rates in the world, besides Japan and Switzerland. The German government has just issued 30-year debt at a negative yield. Provided the government can identify investment projects that are sufficiently profitable to repay the principal, increasing public investment would seem to be a no-brainer.
Germany does face large implicit pension and health-care related liabilities due to a rapidly aging population– more so than the other major economies. The IMF puts the net present value of pension and healthcare spending at respectively 40% and almost 50% of GDP during 2015-2050. This is a relatively large amount. It therefore makes good sense to maintain a strong fiscal position. However, a temporary fiscal stimulus worth 1-2% of GDP won’t make much of a difference in terms of the long-term health of public finances. The key term here is temporary. Keynesian fiscal policy foresees that the stimulus be withdrawn once economic activity returns to potential. But even if Germany decided in favour of a permanent increase in spending or decrease in revenues of 1% of GDP, this would keep the debt ratio on a downward trajectory over the medium term. Germany’s cyclically-adjusted or structural budget balance was 1.2% of GDP (surplus) last year and is projected by the IMF to remain above 0.5% of GDP. Assuming modest) nominal GDP growth of, say, 2%, Germany could easily provide 1% of GDP worth of stimulus, even permanently, and the debt ratio would continue to decline. All of this is to say that Germany could afford a fiscal stimulus – especially a temporary one.
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| Source: IMF |
Germany does face large implicit pension and health-care related liabilities due to a rapidly aging population– more so than the other major economies. The IMF puts the net present value of pension and healthcare spending at respectively 40% and almost 50% of GDP during 2015-2050. This is a relatively large amount. It therefore makes good sense to maintain a strong fiscal position. However, a temporary fiscal stimulus worth 1-2% of GDP won’t make much of a difference in terms of the long-term health of public finances. The key term here is temporary. Keynesian fiscal policy foresees that the stimulus be withdrawn once economic activity returns to potential. But even if Germany decided in favour of a permanent increase in spending or decrease in revenues of 1% of GDP, this would keep the debt ratio on a downward trajectory over the medium term. Germany’s cyclically-adjusted or structural budget balance was 1.2% of GDP (surplus) last year and is projected by the IMF to remain above 0.5% of GDP. Assuming modest) nominal GDP growth of, say, 2%, Germany could easily provide 1% of GDP worth of stimulus, even permanently, and the debt ratio would continue to decline. All of this is to say that Germany could afford a fiscal stimulus – especially a temporary one.
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| Source: IMF |
Critics find Germany’s reticence to loosen fiscal policy all the more puzzling given allegedly large infrastructure investment needs. Why not borrow at no cost and upgrade Germany’s supposedly deteriorating infrastructure? It is less obvious that it may at first appear that (1) Germany is in need of significant (public) infrastructure investment and that (2) the government is well-placed to identify sufficiently profitable public investment projects. Interestingly, liberal economists are typically quite skeptical about a state’s ability to pursue a successful industrial policy and yet they want the German government to increase investment spending significantly. Critics contend that Germany’s investment needs are tremendous, ranging from broken bridges, a decrepit railway system and a digital and technological infrastructure that is severely lagging. Germany would no doubt benefit from upgrading its infrastructure, especially in light of its Industrie 4.0 targets. But it is also worth putting things into perspective. Germany ranks number in terms of the World Bank’s Logistics Infrastructure Performance Index. So identifying investment projects with high financial and social returns may be more difficult that is sometimes suggested. After all, repeated Japanese attempts to drag the economy out of stagnation and depression arguably yielded little – even though how successful or unsuccessful these policies were depends on one’ counterfactual – in terms of short- and long-term growth. This argument is debatable, admittedly. However, as far as large-scale infrastructure investment is concerned, it is advisable to proceed carefully.
Naturally, a fiscal stimulus does not need to rely on public infrastructure investment and is actually bound to be more effective in terms of its counter-cyclical impact if it focuses on consumption. Counter-cyclical fiscal policy should be timely, targeted and temporary. Investment often requires significant lead times, while a consumption-oriented stimulus generally kicks in more immediately, especially if it is time-limited. It is also easier to set and credibly commit to such a time limit, compared to investment projects whose costs and length are often difficult to predict with much precision. Germany did exactly that in response to the global recession following the global financial crisis in 2008-09. The so-called cash-for-clunker scheme successfully supported domestic German demand and more specifically the German car industry in a timely, temporary and targeted way. None of this is to suggest that Germany would not be well-advised to examine very closely ways to boosting infrastructure investment. But there may be more cost-effective way of going about providing short-term support to the economy. And if fiscal space is meant to do more than provide a temporary stimulus, the government should draw up investment plans and funding, perhaps involving private-sector participation to make them more effective and less costly for the government. While an investment-focused (deficit-financed) spending programme is desirable from a longer-term productivity and growth perspective, a short-term stimulus will be more effective from a short-term stabilization point of view.
Is there then an economic rationale for not deciding in favour of a fiscal stimulus? At present, German unemployment is near all-time lows and labour participation is very high. Granted unemployment is a backward-looking indicator. But the urgency of a fiscal stimulus is limited from a political perspective. The German government also seems to be uncertain about the economic outlook and about how temporary or prolonged or severe the economic slowdown will be. The Fed, for example, is facing a similar dilemma. Until recently the US data looked reasonably solid, but the markets and commentators were increasingly negative on the outlook and forced the Fed into policy easing. Moreover, the German budget has significant built-in automatic stabilisers, making discretionary measures less necessary and urgent than in countries with smaller budgets and/ or fewer fiscal stablisers (e.g. United States). Then there is the issue of getting the timing right. The economic indicators arguably are sending somewhat mixed signals (or did) and the German government may consider it premature to open the fiscal tabs, or turn on the fiscal tabs, but then the slowdown proves temporary. Last but not least, fiscal stimulus policies tend to less effective in a very open economy (low fiscal multiplier due to leakage of domestic demand abroad). A coordinated fiscal expansion would be more effective, but this would run into German political concerns about loosening hard fought for constraints on euro area member fiscal policies. None of these arguments points to a complete ineffectiveness and political unwillingness to move towards a looser fiscal policy stance. But they seem to make it more justifiable to proceed cautiously and sensibly.
What are the political factors accounting for Germany’s greater fiscal restraint? First, the German constitution puts limits on fiscal flexibility, more specifically the size of the fiscal deficit (so-called Schuldenbremse). (The constitutional provision should perhaps best be seen as a reflection of Germany’s cautious attitude towards Keynesian policies rather than as the source of Germany’s restraint.) Second, the present (like the previous) finance minister is reluctant to abandon the commitment to the so-called “black zero” (no deficit) – or is at least reluctant to abandon it if that can avoided. Acting too rashly is not a desirable choice. Third, ordo-liberalism has always had a strong foothold in German economic thinking and culture. Given the uncertainty that continues to attach the economic outlook, this also helps explain German caution. The commitment to ordo-liberalism makes Germany not only – rightly or wrongly – skeptical about discretionary market intervention and policies. It also makes German policymakers less certain about their ability to get the timing right. Once again, none of this suggests that a fiscal stimulus won’t be forthcoming. Just that German policymakers are more cautious and that the political consequences of slower economic growth have been negligible so far.
It made sense to resist fiscal expansion during the euro area crisis when Germany’s economy was operating at close to full capacity in order to save fiscal space for the next downturn. We may now be witnessing this very downturn. Should the economic outlook deteriorate further and, in particular, should labour market conditions deteriorate sharply, Germany is very likely to move towards a modest fiscal stimulus. Germany is more skeptical about the usefulness and effectiveness of demand management policies for historical and economic reasons. A strong political commitment to fiscal rectitude - strengthened recently in the context of euro area governance reform - also makes the German government more reluctant to shoot - or to be seen to shoot - from the hip. Nonetheless, Germany will in the end recognize that it is in its self-interest to opt for a modest degree of fiscal expansion. It did so in 2009 and it will do so again should the economic situation deteriorate further. For all the reasons analysed above, however, German policymakers are and will remain reluctant or - if you will - cautious Keynesians.