German Chancellor Angela Merkel will meet with President Obama today, June 26, in Washington to deepen US-German cooperation on economic, security, and climate-change issues. An unfortunate quote of mine to a German paper from some months back has been trotted out in the press to exemplify informed American skepticism on the German governing coalition’s economic views. I regret my phrasing—it is always wrong to speak about individuals instead of policies, and in this instance it ignores my sincere admiration of Chancellor Merkel’s very strong and brave leadership on the foreign-policy front. But my substantive dispute with the German Christian Democrat and Social Democrat (CDU-SPD) governing coalition’s economic views as she has expressed them, often in terms very critical of US and other countries’ policies, bears explanation.
Merkel and President Nicolas Sarkozy of France were right to push the G-20 on financial reform and regulation in March. Except for some posturing on hedge funds, the Obama administration proposal and the EU proposals are actually not that far apart from each other. But they are, to my mind, insufficient in terms of not being tough enough and of not coordinating internationally. So a plague on both their houses for that. For all their rhetoric criticizing financial speculation of an Anglo-American bent, though, the German and many other Western European banks made many of the same mistakes. If anything they are in more trouble at this point than the American banks, because they haven’t written down as many losses yet, and these troubled institutions are more important to the economy of the European Union than their counterparts in the United States and Britain.
Chancellor Merkel, of course, has every right to express her own views on US government policies, on the US Federal Reserve, and on the European Central Bank (ECB). But her excessive concern for inflation, while playing to German historical images, is unfounded in the current context. Inflation is a risk to be watched seriously, but the worst-case scenario in today’s world would be a rerun of the
Volcker-Reagan [pdf] episode of the early 1980s, which was a case of the Fed acting aggressively to contain inflation when the budget of an elected government was too loose for too long. That was not fun, but central banks have learned that lesson from the 1970s and 1980s. And that was not a case of accelerating high or hyperinflation. Even this risk of repeating the early 1980s is more a question of governments’ than central banks’ behavior at this point.
Turning to the governments’ behavior on the budgetary side, the fiscal stimulus debate is over. Germany ended up with a larger fiscal stimulus than most other European economies, going beyond its already-larger automatic stabilizers. The United States and Europe all moved, in varying degrees, in the same direction. Merkel was premature in attacking the United States for fiscal laxity earlier this year. The stimulus and temporary deficits employed to respond to the crisis are not the problem. The real problem is that we are likely to have a huge expansion in healthcare coverage without doing enough to pay for it initially. (I support the expansion of our healthcare coverage; I just want taxes to pay for it.) That is what may lead to a
US fiscal or dollar crisis [pdf] in a few years. Activism to respond to the current crisis was right. It is therefore all the more odd for some German parties heading into September’s elections, including Merkel’s Christian Democrats, to now talk about tax cuts domestically postcrisis.
The real problem is that Germany deterred some other countries in Europe from fiscal stimulus programs in response to the crisis. This is part of a broader difficulty of Germany leading a drumbeat for excessive discipline, particularly aimed at non–euro area EU members in Eastern Europe. This approach is going to backfire badly, both politically and economically, for Western Europe. In the process, the euro is squandering its chance to upstage or displace the dollar. With euro-area governments going into a defensive crouch and making it clear that there will be no EU enlargement (at least not on any kind of reasonable terms), this one moment when the EU was of maximum relative size/influence has been thrown away. [pdf]
There are two underlying issues that the current German government has to confront, beyond the upbraiding of the United States. First, if Merkel and many other Germans and Europeans believe that global imbalances were part of the cause of this crisis, and they clearly do, then Germany must be prepared to accept an appreciation of the euro (versus the dollar and overall) and to maintain smaller trade surpluses. She may recognize this, but most of Germany’s business and political leadership do not. They may not have a choice in fact, if the Chinese push successfully for a reserve currency shift into Special Drawing Rights (SDRs) and thus into euros.
Second, the German economy has done poorly on productivity growth and wage growth for many years. Being the big exporter is thus failing them on long-term performance, as well as leaving them very vulnerable short-term during this global contraction. Rhetoric about improvements in German competitiveness is not justified by the data. The Germans, in other words, will have to reconsider their economic model to bring about sustainable growth, even if trade recovers following the current global crisis.