Winston Churchill once said of Russia that it was “a riddle, wrapped in a mystery, inside an enigma.” The White House probably has the same feeling of Germany today. There is no love lost between President Obama and Chancellor Angela Merkel. The division between their views of current economic strategy only grew bigger at the last G20 Summit in Toronto. Two years ago, while campaigning to become the new American president, Obama was cheered by a few hundred thousands of people on Brandenburger Tor in Berlin. Today, Berlin is the main opposition to the White House’s view of the grand engineering of global economic recovery. In fact, Chancellor Merkel is more of a political threat to Obama than the disunited Republican Party or the noisy Tea Party movement.
Blame for recent economic chaos in the Eurozone could certainly be laid at the door of the German Chancellery. Angela Merkel flip-flopped on the bailout of Greece and how it should be organized, causing unnecessary angst in financial markets over Europe’s capability to handle problems in its own backyard. The German government’s recent decision to ban short selling of some financial papers was silly. Such moves have little effect when papers can be traded on many exchanges outside Germany, and if anything, this rash action triggered worries about the economic instability of firms, mainly banks, covered by the ban. Moreover, it threw several other countries and firms into acute economic problems—especially commodities and securities heavy currencies. Hence, it worked as a classic beggar-thy-neighbor policy.
Yet it is difficult not to support the underlying rational of the German-led trend of fiscal stabilization that has recently started in Europe. And it is this old “Bundesbank obsession” with fiscal balance and keeping politicians away from printing money that is annoying White House economists who want to see other big economies fuel the recovery by expanding fiscal deficits. Some economists, like the notorious New York Times scribbler Paul Krugman, go even further and opine that the new drive towards austerity will kill recovery and throw the world into a an economic depression. They are wrong—and also falsely portray current policy.
First, neither Germany nor any other significant EU economy with big deficits plan to balance their books anytime soon. Under current “austerity” plans, countries like Germany and the United Kingdom will run fiscal deficits for years to come. Fiscal tightening will mainly start in 2012, and in the next few years the reduction in deficits is largely planned to come by economic growth.
Second, many EU countries need to make credible plans for deficit reductions because their high levels of debt are causing problems. Current distrust in European economies is not only about the cyclical deficit. Overall, high levels of debt and worries about how future entitlements will be paid when the population grows older were concerns already before the start of the crisis and have grown toxic since then (mind you, this future is only a few years away). The average level of public debt in the European Union in less than a decade is expected to be above 120 percent of Gross Domestic Product (GDP). That amounts to a big debt crisis.
True, it is theoretically possible, as argued by some, that governments could devise strategies now to deal with the long-term debt problems without starting fiscal tightening soon. This would allow for a stimulus-fuelled recovery in the next few years, and then the actions against unsustainable levels of debt could kick in. But this strategy only works in theory. No government could make credible proposals for addressing debt levels in the future—say, three or four years from now—as no one knows who will be in power by then. Furthermore, if a program for future debt consolidation (and reduction), which involves spending cuts and tax increases, would be launched now, people would start to adjust now for future austerity by saving more and spending less. This would undermine, and possibly radically so, the effect of current stimulus programs.
Third, while the US sits on the reserve currency of the world and can take up new loans without fuelling future inflation and interest rates, European governments simply do not have that luxury. Bond rates have already gone up, and especially so for governments with significant deficits. Furthermore, there are looming inflation threats by current macroeconomic policies. Enormous amounts of money have been pumped into the economy, but money is being hoarded rather than spread out. At some point, this money will find its way into the larger economy.
Finally, while the automatic stabilizers are good anti-cyclical policy, the effect of discretionary fiscal stimulus is smaller than expected. This is true also for the United States. In an open world economy, stimulus money leaks to other countries in the world.
Fredrik Erixon - Director and co-founder of the European Centre for International Political Economy (ECIPE).
