GERMANY AND THE €-ZONE CRISIS

Jörg Bibow, Skidmore College & Levy Economics Institute, New York

World Economic Roundtable, New America Foundation & World Policy Institute,NYC, 12 June 2013

AIM & MESSAGE

AIM: Explore Germany’s central role in the ongoing Euro-zone crisis

MESSAGE: Having misinterpreted its own economic history, Germany is forcing an unworkable policy regime upon Euro-zone Posing great risk to global recovery Germany blind to its own vulnerability

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STRUCTURE OF TALK

1. The “German model” 2. The trouble with exporting the German

model3. The key causes behind Euro-zone crisis4. Unimpressive pre-crisis performance 5. Crisis (mis-)management6. Conditions for proper crisis resolution7. Concluding remarks

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1. THE GERMAN MODEL

“price stability above all else” Lower inflation actually caused growth in Germany

in environments of fixed nominal exchange rates COMPETITIVENESS

Independent Buba as referee: to check labor unions and fiscal policy DISCIPLINE

Asymmetric MP; no job in stimulating demand

Relying on export engine worked for Germany because and as long as others behaved differently Easier to balance budget alongside external

surplus

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A HISTORY OF EXTERNAL SURPLUSES

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2. THE TROUBLE WITH EXPORTING IT Maastricht meant export of Germany model

Meant trouble for Germany because key trade partners now required to be like Germany

Some temporary factors in 1990s + Interest-rate convergence, “new economy” boom - “burden” of German unification (“transfer union”)

So Germany became “sick man of the euro”

German response: more wage repression, fiscal austerity, and structural labor market reforms

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MIRACULOUS HEALING OF THE SICK MAN

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3. KEY CAUSES BEHIND €-ZONE CRISIS

Deep cause: regime flaws1) Cutting the Treasury-CB nexus of sovereign

states2) Nobody “minding the store”3) No proper policy coordination to ensure

convergence and cohesion of union

More immediate cause: German misbehavior How wage repression, structural reform, &

mindless austerity in Germany undermined currency union

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1) TREASURY-CB NEXUS RATHER VITAL

National treasury strengthened by national CB underwriting of financial system liquidity, just as CB strengthened by Treasury’s “deep pockets” Treasury-CB nexus vital to safeguard liquidity

and solvency of banking system

Euro decoupled member states’ national CB and national Treasury, while ECB not meant to be LOLR and Euro Treasury nonexistent Strength! Says German model of central banking

CB independence “above all else” (Buba as referee) Hyper-fears of “fiscal dominance” (Weimar, MEFOs)

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2) NOBODY “MINDING THE STORE”

No demand management foreseen in good times “Stability-oriented” monetary policy asymmetric

“Below 2%”: Quick to hike, slow to ease = anti-growth bias “Disciplined” fiscal policy asymmetric too

“Below 3%”: deficits can be “excessive” but never too small

Policy mix? No, as coordination threatens CBI! Fiscal stance random, macro policy mix set by ECB

No LOLR foreseen in bad times “Market-policy domain problem”: common market

but no common policy = fragility, as markets “off the leash” and without backstop Today: Common financial market without “banking union”

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3) CONVERGENCE NOT ENSURED Euro-zone members commit to common inflation rate

ECB: “below but close to 2%”

“Golden rule of currency union”: National ULC trends must be aligned with common inflation norm As nominal exchange rates eliminated, relative ULC trends

determine intra-area competitiveness positions While € determines extra-area competitiveness

Diverging national ULC trends undermine union Divergences cumulative, lastingly distort competitiveness

positions, causing current account imbalances And persistent CA imbalances involve debt buildups

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4. UNIMPRESSIVE PRE-CRISIS PERFORMANCE

Business cycle Brief booms, long (domestic demand)

stagnations Remarkably export-dependent for large economy

Growth and policy outcomes Declining trend growth rate HICP (headline) inflation mostly above 2% Budget deficits mostly above 3%

Buildup of massive divergences and imbalances

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NOTORIOUS GROWTH LAGGARD

Lack of domestic demand management Persistent high unemployment Budget pressures, so SGP provokes tax hikes While ECB thinks it is not responsible Alas, MP and FP shoot each other in the foot!

Both missed their magic numbers!

Official blame on “structural problems” Hence “structural reform” as panacea Strangely, Germany never had a problem

growing on strong export stimuli13

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LOW GROWTH AND “TAX-PUSH INFLATION”

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DIVERGENCE! EUROPE CONVERGES TO GERMANY’S HISTORICAL STABILITY NORM BY MID ‘90S

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3€ launched

€ crisis1980s 1990s 2000s

BUT GERMANY ITSELF DIVERGES

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‘lost competitiveness’ but Germany

NASTY CONSEQUENCES!

One-size-does-NOT-fit-all ECB policy Too tight for Germany … domestic demand flat Too loose for periphery … ‘hello’ bubbles …

Germany turns “über-competitive” Internally, Euroland seriously unbalanced Externally, euro exchange rate too weak for

Germany, too strong for rest

= ASYMMETRIC SHOCK!!!

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MAASTRICHT REGIME AMPLIFIES TROUBLE

As Germany suffocates domestic demand, macro conditions become relatively tighter Financial conditions, credit, property prices … More SGP prompted austerity … vicious circle …

While ECB stance becomes too easy for periphery Financial conditions, credit, property prices … Fiscal ease as public finances seemingly healthy

Feedback loops sustain & amplify divergences, smoothly financed by liberalized & integrated markets; fragilities build up; supervisors dozing

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CURRENT ACCOUNT IMBALANCES

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As flows change stocks,

debts build up …

GERMANY’S “EURO TRILEMMA”

As Germany’s CA surplus and NIIP balloon, partners see their position deteriorate

Pre-crisis Germany’s CA surpluses concentrated in EU, and so are financial exposures!

Germany cannot have all three: perpetual CA surpluses, a no-transfer/no bail-out currency union, and a “clean” independent CB

Germany is on the hook! 20

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5. CRISIS (MIS-)MANAGEMENT

Fiscal policy Brief ‘Keynes moment’ in 2009 Followed by mindless austerity since 2010

Fiscal support to financial sectors Guarantees, recapitalizations, deposit insurance

etc. ECB monetary policy

Foolish hikes, delayed easing (i.e. business as usual)

ECB as LOLR to banking systems Various, culminating in LTROs

ECB as LOLR to governments (indirectly) SMP, finally: OMTs = Mario’s magic bullet

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ESSENTIALLY, OFFICIAL FLOWS REPLACING PRIVATE FLOWS AS BOP CRISIS UNFOLDS

Private exposures turning into official exposures Bilateral loans (Greece bailout no. 1 etc) EFSM/EFSF, ESM ECB bond holdings (SMP … OMTs …) Intra-Eurosystem (TARGET2)

Note: So-called ‘bail-outs’ and Buba’s TARGET2 position are NOT new net exposures Measures just allowed banks to pull out

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MEANWHILE, RE-LOADING/RE-SOURCING OF GERMAN EXTERNAL SURPLUSES

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6. CONDITIONS FOR PROPER CRISIS RESOLUTION?

Crisis resolution - and sustaining EMU - has three parts to it, and one precondition1) Rebalancing the currency union

Restoring intra-area equilibrium (transition; flows)

2) Fair deal on debt legacies Balance-sheet cleanup (past; stocks)

3) Fixing (Maastricht) EMU regime Establish viable EMU regime (future)

Precondition: robust GDP growth

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1) ASYMMETRIC REBALANCING = DEBT DEFLATION

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As convergence to Germany’s historical norm not good enough!

Even France – after staying 2% path – forced into debt deflation

2) DEBT DEFLATION & GROWTH CRISIS MAGNIFY NEED FOR DEBT RELIEF “The more the debtors pay, the more they owe” (I.

Fisher 1933).

Real GDP (2013 relative to pre-crisis peak, IMF WEO April 2013) Greece: minus 23% Ireland, Italy, Portugal, Spain, Cyprus, Slovenia: minus 5-

10% France: zero // Germany: plus 3%

Even nominal GDP is shrinking! (2013 relative to pre-crisis peak, IMF WEO April 2013)

Greece: minus 20% Ireland, Italy, Portugal, Spain, Cyprus, Slovenia: minus 1-

10%

Unemployment skyrocketing, investment plunging, debt ratios soaring!

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3) “MORE-OF-THE-SAME” STYLE REFORMS MEAN PERPETUAL AUSTERITY

Strengthened SGP cum ‘Fiscal Compact’ Balanced budgets forever, implies public debt ratio

converging to (near) zero Either private sector has to seize being net saver or ROW

tolerate perpetual, large €-zone CA surpluses (=German model)

Banking Union & Macroeconomic Imbalance Procedure BU concerns future crises (“market-policy domain problem”) MIP about acquittal of Germany, turning key blunder into

virtue (to justify more structural reform)

Structural reform NOT a growth strategy though As distributional impact further undermines domestic

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AS ‘GROWTH-FRIENDLY’ CONSOLIDATION TAKING ITS TOLL, WILL ROW REALLY PUT UP WITH ‘GERMANIZED EUROPE’?

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7. CONCLUDING REMARKS Asymmetric rebalancing by lethal mix of mindless

austerity and structural reform = debt deflation

Ultimate cost of crisis & need for debt relief rising

‘More-of-the-same’ regime reforms counterproductive

Recent shift in strategy, i.e. faster structural reform for delayed austerity, no growth strategy either!

Global tensions? Currency wars, trade wars …

Need for Euro Treasury and spending from center!!! 29

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THANK YOU!Background to ‘Germany and the Euro-zone crisis’ ‘The Euroland crisis and Germany’s euro trilemma’,

Levy Working Paper no. 721, May 2012, http://www.levyinstitute.org/pubs/wp_721.pdf

International Review of Applied Economics, online version, October 2012, http://www.tandfonline.com/doi/abs/10.1080/02692171.2012.721757

‘At the crossroads: The euro and its central bank guardian (and savior?)’, Cambridge Journal of Economics, 2013 Levy Economics Institute, Working Paper no. 738, November,

http://www.levyinstitute.org/pubs/wp_738.pdf ‘On the Franco-German euro contradiction and ultimate euro

battleground’, Contributions to Political Economy, 2013 Levy WP no. 762, April,

http://www.levyinstitute.org/publications/?docid=1740 ‘Germany and the euro crisis: The making of a vulnerable haven’

Levy WP no. …, June, coming soon

See my homepage http://www.skidmore.edu/~jbibow/research.htm At Levy Economics Institute

http://www.levyinstitute.org/scholars/?auth=20 30

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