Germany’s Über-Economists Are Rampant Again

The rest of the world is holding its breath as the eurozone continues wobbling along the brink of deflation. In fact, numerous member states are already experiencing what it means to let “it” happen again. With the region stuck in depression since 2008, Euroland authorities are writing fresh world records in failing to improve the well-being of their citizens. The only thing that keeps rising in the eurozone is indebtedness—as the unsurprising consequence and symptom of its collective austerity insanity.

But that is not how the German authorities, or for that matter German economists, view the world. Blatantly ignoring the dismal facts that their favored medicine has produced, they never tire of calling for more of the same: austerity, austerity, and another extra dose of austerity please. By contrast, anything that might possibly help to turn fortunes around gets rejected out of hand as conflicting with the requirements of stability-oriented policymaking. In Germany, neither facts nor economic theory matter at all, it seems. Policy prescriptions simply have to match the ruling austerity-cum-competitiveness ideology, no matter what.

Hans-Werner Sinn, president of Munich’s IFO think tank, provided us with a fresh sample of German economic wisdom about a month ago, calling on Germany’s Chancellor Angela Merkel to stop ECB President Mario Draghi from even trying to regain control over its primary price stability mandate, defined as “below but close to two percent” inflation. Eurozone HICP inflation is currently running at only 0.3 percent. But even the thought of the ECB purchasing government bonds is giving rise to hyperinflation fears among German economists, it seems. It’s all a matter of principle and firm belief.

Professor Sinn is known to readers of Germany’s tabloid Bild-Zeitung as the country’s smartest economist. As if to confirm this popular verdict, Professor Sinn was at least making one valid point in his FT op-ed: namely, that the ECB has finally stopped ignoring super-low inflation while the eurozone’s political leadership remains stuck in denial. As the political authorities continue dreaming their austerity-boosts-growth delusion, the ECB (at last) has started devising actions intended to stop the nightmare reality from getting worse. To be sure, it is not an enviable position for any central bank to be in. The ECB is learning the hard way that not having a euro treasury partner means doing the tango on your own (which may look somewhat curious, if not ridiculous). But perhaps some central bankers have come to realize that not even trying to solo-dance might be judged as gross negligence should the eurozone end up sinking into full-blown deflation and chaos.

Professor Sinn reminds his fellow German citizens that they may petition the German Federal Constitutional Court in case they fear that their country’s Basic Law gets trampled upon. The law says that Germany can transfer monetary policy to a European institution that is independent and committed to the primary goal of price stability. This would seem to open up the interesting possibility that the court, if petitioned by its citizens, could also force German politicians to take action against the Bundesbank for failure, as part of the Eurosystem, to effectively stem deflation. Of course this is not exactly what Professor Sinn has in mind. It is utterly inconceivable that Germans, supposedly scared of nothing else in the world but hyperinflation, could ever worry too much about the opposite threat wreaking havoc across Europe—even as destructively-low inflation has been the reality for quite some time now.

And then there is Otmar Issing, formerly a professor of economics at Würzburg University and chief economist at the Bundesbank and then the European Central Bank. His recent FT op-ed is a response to worldwide calls on Germany to change its steadfastly-held austere fiscal stance and finally help the eurozone to recover. Here is Professor Issing’s diagnosis of the situation:

Imagine you are asked to give advice to a country on its economic policy. The country enjoys near-full employment; its growth is above, or at least at full potential. There is no under-usage of resources—what economists call an output gap—and the government’s budget is balanced, but the debt level is far above target. To top it all monetary policy is extremely loose. This is exactly the situation in Germany. Recently forecasts for growth have been revised downwards, but so far the overall assessment is unchanged. At present there is no indication of the country heading towards recession. Inflation is low but there is no risk of deflation. From a purely national point of view Germany needs a much less expansionary monetary policy than it is getting from the European Central Bank. This is a strong argument why fiscal policy should not be expansionary, too. Where is the economic textbook that argues that such a country should run a deficit to stimulate the economy? There is hardly a convincing argument for such advice.

In arguing the German case against spending more, Professor Issing gave us a nice lecture from his personal textbook. It came as no surprise that he chose to remain silent on the most conspicuous fact, perhaps because certain pages may be missing from his text. I am of course referring to Germany’s gigantic current account surplus of over 7 percent of GDP. At least to economists outside of Germany that size of external imbalance, together with an inflation rate of close to zero, stagnant domestic demand, and a balanced budget, cries for more spending like nothing else. The logic is quite impeccable actually. More German spending would boost both German inflation and German imports—exactly what Europe and the rest of the world rightfully expect from a country that is as seriously unbalanced and vulnerable as Germany today.

I am all too well aware that the German audience is used to another piece of advice from Professor Issing’s text though. It reads: When Germany stagnates, don’t worry, just lean back and wait until the rest of the world stimulates German exports, pulling the German economy along, and at little inflation risk too. That strategy worked just fine for the legendary Bundesbank. Alas, and quite predictably so, the German model has landed the euro area in a terrific mess.

Even today, Germany’s domestic demand is only little above its pre-crisis peak, while the eurozone’s domestic demand is still way below its pre-crisis peak. Meanwhile, the eurozone’s current account balance is “going German” as the area’s surplus is by now exceeding two-and-a-half percent of GDP. The eurozone authorities have stopped referring to global imbalances because they are now the biggest contributor to such imbalances in the world.

No doubt Germany’s global partners have every reason to be fed up with so much German-style freeloading. As for Germany’s euro partners, beware that at some point they will be forced to conclude that sharing a currency with Germany is simply unworkable. The consequences of a euro breakup would feature large-scale wreckage in Germany. The German authorities are well advised to finally ditch Professor Issing’s text and adopt an international one instead. Germany would do itself a great big favor.

But Germany is unlikely to do so, or even mildly change course, unless something really rocks the boat. With economists like these, one might wonder, who needs any proper weapons of mass destruction anymore? Germany’s finance minister Wolfgang Schäuble is a jurist rather than an economist, but it appears to me that he firmly believes that he has figured out economics all by himself—German economics, that is. About a year ago he was leading the way to the promised land, hallucinating publicly about some “parallel universe” inhabited by economists holding strange views that differ from his own. He then declared the following in an FT op-ed:

The world should rejoice at the positive economic signals the eurozone is sending almost continuously these days. While the crisis continues to reverberate, the eurozone is clearly on the mend both structurally and cyclically. What is happening turns out to be pretty much what the proponents of Europe’s cool-headed crisis management predicted. The fiscal and structural repair work is paying off, laying the foundations for sustainable growth. This has taken critical observers aback. It should not have, because, in truth, we have seen it all before, many times and in many places. Despite what the critics of the European crisis management would have us believe, we live in the real world, not in a parallel universe where well-established economic principles no longer apply.

The real world may be too depressing and denial a more attractive alternative, but the eurozone depression is purely man-made—made by men who truly live in a parallel universe.