Winner of the New Statesman SPERI Prize in Political Economy 2016

Saturday, 13 September 2014

Can a country be too competitive?

In my earlier post on the failure of the Eurozone to understand the lessons of the Great Depression, I talked about Germany becoming ‘too competitive’. From some comments it seemed this was a contradiction in terms: how can a country ever be too competitive? I think it was obvious then that I was talking only about relative prices: being competitive in quality is something else. The problem is that Germany did become too competitive in price terms from 2000 to 2007 relative to pretty well all its Eurozone partners.

Graphs that compare some measure like unit labour costs over this period in Germany and some periphery country are ubiquitous. The discussion normally moves on to talk about how this was a problem of the periphery country’s own making alone: for whatever reason demand was too strong, which put upward pressure on inflation. However, as Francesco Saraceno points out, the really notable outlier here is Germany. Germany did not just increase its competitiveness relative to particular periphery countries; it also became more competitive with its immediate neighbours. From 1999 to 2008, whole economy unit labour costs were flat in Germany, compared to average annual increases in France of 2%, in Italy 3%, in Belgium 2.1%, in the Netherlands 2.3%. (Source OECD Economic Outlook Annex Table 22.)

The reason for this was a remarkable degree of real wage restraint in Germany. The chart below plots annual increases in real wages in Germany (either relative to the CPI or the GDP deflator) compared to labour productivity. Although these two series do not always move together, divergence between real wages measured relative to the GDP deflator and labour productivity are unusual because they imply a changing share of labour income.

German real wages and productivity: source OECD Economic Outlook

Whatever the reason behind this unusual wage restraint, it is bound to cause problems within a monetary union if other countries do not do the same. Unless Germany entered the Euro at an exchange rate that was unsustainably uncompetitive (and there are good reasons for doubting this possibility), and unless there is a structural deterioration in Germany’s non-price competitiveness that needs to be offset (which seems unlikely given its huge current account surplus), then these competitiveness gains have to be reversed. German inflation, which was below the rest of the Eurozone, will have to be above inflation in the rest of the Eurozone for some time. These are the rules of the game for a monetary union. 
As Germany is the outlier, this is a problem of Germany’s making. I’m normally reluctant to mix macroeconomics with morality, but those that suggest that it should be other countries that have to adjust towards Germany have things completely wrong here. Even if you believe that German real wages had to fall to reduce structural unemployment, Germany has no right to impose the same policy on other countries. A price it should pay for undercutting its neighbours is to experience a period of above ECB target inflation (e.g. 3% CPI inflation, which probably means nominal wage increases of something between 4% and 5%). If that is not going to happen, Germany should stimulate its economy to ensure it does. Anything else is the monetary union equivalent of anti-social behaviour.


  1. I appreciate your efforts but you are trying to fight a political (and morality/trust) problem with economic arguments.
    The German public has been sold a totally different story and is only very slowly starting to realize what is going on and I am not convinced that they will come to the right conclusion.
    You are argueing against a people that irrationally believes in the following myths:
    1.) Inflation of 0% is best.
    2.) Trade is a zero-sum game and Germans have to be on the top to dictate terms. This is especially true for employment.
    3.) The eurozone should run large net export surpluses to conquer markets. High net-exports are something to be proud of.
    4.) Southern European governments cannot be trusted.
    5.) Equity investments (except for a self-used house) are pure gambling.
    6.) Everybody in Germany had to sacrifice something and not only labour incomes.

    I my view 6.) is the key to changing the economic debate in Germany and to make the public realize what the reduced labour cost policy has done.
    But this is really difficult for two political reasons:
    a.) The centre-left parties who are more likely to refute 6.) for ideological reasons have implemented the very same policies.
    b.) Low employment is more important than high growth for politicians.

    1. Oh, I forgot
      7.) Debt is always bad. A balanced budget is an end to itself.
      8.) Rules have to be followed even if they make no sense like the SGP.

    2. 1.) I don't think that this is the view of the German public or orthodoxy. Germany has no problem with 0% inflation per se though, that much is true.
      2.) Trade is not a zero-sum game but as Germany's performance throughout the crisis shows: market-shares matter. So trade is a mix of creating win-win siutations *and* being competitive with your products versus others at the same time.
      3.) This is a prevalent theme in the German public, yes. The equivalent net capital export that resulted in malinvestment tends to get overlooked.
      4.) See Greece. Heck, see even France's broken promises of keeping its deficits in check. It might be unfair as a sweeping generalization but it's not like there isn't any reason for distrust. There is particular concern about the crisis countries trying to turn the Euro from a Euro-DM to a Euro-Lira.
      5.) The dot-com bubble didn't help, I fear. Instead, German savings end up in Greece bonds or Spanish real estate. Or Lehman certificates.
      6.) I am not sure that there is widespread agreement here that everybody had to sacrifice something. It's clear that labour had to make the sacrifices. However, Germany's success in recent years has largely killed off complaints about Schröder's Agenda 2010. So proponent's of the strategy feel vindicated.
      7.) Debt is not always bad but accumulating ever larger debt is. A permanently imbalanced budget (and increasingly so) is bad and makes a country vulnerable. If debt is used for investment, an investment can be expected to amortize sooner or later... leading back to original debt levels. Growing debt levels are indications of malinvestment and/or consumption.
      8.) Rules do matter. If you think they make no sense, don't break them - change them.

  2. I can definitely tell you about the reason behind the wage restraint. At the end of the 90s, Germany was the sick man of Europe. We were told (by the usual suspects, OECD, IMF, all kinds of interest groups) that there was some belt-tightening that had to be done. Not only cuts in the welfare net, but also cuts in real wages. The German population accepted because it seemed that the alternative was the loss of the manufacturing sector to China and the other Asian countries and mass unemployment (which indeed reached record levels in the final years of Chancellor Kohl's government). Germany's federal institutional set-up (strong unions, strong industrial representation, mediation by the state) and the social democratic/green government of the time (1998-2005) probably eased the acceptance of these cuts. You said to me that labor was duped when it accepted the cuts, but the success of these measures is clear now. The manufacturing share of GDP in Germany is at 22% according to the World Bank. In the UK and France it's 10%, 13% in the USA, the labor participation rate in Germany has increased against bad demographic trends and has probably peaked now at 60% (France at 55%, UK at 62%, USA at 65%).
    However, I still don't understand why gains in competitiveness HAVE to be reversed. What happens if they don't? What's the mechanism that leads to problems? Lower wage costs makes export goods cheaper. But this has its limits, mainly that Germany is very close to full employment now and thus can't absorb any more industrial activity that would otherwise go to other european countries.
    The question of morality is misleading, maybe even a bit mean. First, Germany gets told to give up the Deutsche Mark in exchange for re-unification, then Germany gets told to become more competitive in spite of the plans for a currency union (a cruel irony, because those that demanded wage and welfare cuts probably didn't know about the future workings of the currency union even though it was scheduled to happen), then German tax payers are told to bail out other countries and their banks. I suspect that there was some silent agreement that Germany gets to determine the way out of the crises in exchange for its money and reputation. And it was decided to make other Eurozone countries more competitive not against Germany, but against the rest of the world.

    1. To add to that, the reason why Germany became this sick man of Europe was the massive outflow of capital to the European periphery. In the years before and after the introduction of the Euro, the Southern countries could suddenly present themselves as more trustworthy targets for investments. The risk of exchange rate changes was gone and bond reached unprecendented low premiums. The capital from the core countries (and from around the world) then where mainly used to raise wages and fuel an iflationary boom in the periphery.
      Through the capital outflow, the German economy suffered and wages had to be reduced.

    2. "The question of morality is misleading, maybe even a bit mean."

      They're being stupid almost out of spite. In order to help the periphery adjust to the great outflow of capital after the financial crisis and bond crisis, they need to adjust.

      They need to pay their workers more, with more fiscal spending and a slightly higher inflation rate. This could involve more spending on infrastructure, schools etc and more prosperity for German workers. But no, they have to stick to the budget and inflation rules no matter what. Just because.

    3. the beating will continue until the morale improves.

      Germans feel that they made the adjustment albeit in times better suited to the adjustment and now it is time for the PIIGS and others to do the same.

    4. This would mean competitiveness losses against the rest of the world (which makes up 2/3 of Germany's trade partners).

    5. "They need to pay their workers more."

      But that's not something you can ask "the Germans/them" as a whole. You'd have to ask the employers, including foreign companies to do that. Or alternatively, german workers as a whole need to learn to demand higher wages. That's a bit out of character, and it's against the surprisingly good experience german labor had with it's belt-tightening in the early 00s.

      "more fiscal spending and slightly higher inflation"

      The fiscal multiplier of a country at full capacity is below one. It's not going to create much more GDP, it's only going to create inflation, which, I know, is the point. But if the problem with Germany's competitiveness is "unfairly" low wages, then a reversal of that would be the most natural move. Fiscal spending just because is going to inflate asset prices in a way that's not going to be helpful. It's the wages that need to increase, but as I said, that's a tough proposition. Maybe there has to be the kind of reverse shock treatment of the early 00s. Maybe the OECD, World Bank, IMF, and so on, have to exert the same pressure on the german psychology, only the other way round, a common demand for belt-loosening if you will.
      Also, it is extremely tiring to listen again and again what Germany has to do. I don't know why the other countries can't raise fiscal spending themselves. Spending in depressed economies is more effective, especially at the zero-lower bound. That's, in my opinion, what economists should emphasize.

      "But no, they have to stick to the budget and inflation rules no matter what."

      I've been critical of German ordoliberalism as well, but its desire of stability is definitely not just because, at least when it comes to German domestic policy. You have a point with the german desire to extend ordoliberalism over Europe, and as I said above, maybe there is a silent agreement to partly accept that in certain countries. One reason why Germany wants to decrease its debt burden is because of its unfavorable demographics. German population is going to shrink, the debt burden per capita is going to increase. Here is something from the German ministry of finance:
      This is where Germany does significantly worse than France, for example.
      Besides, there is still some room left within the Maastricht framework. Germany's deficit is far lower than the 3% as demanded by the Maastricht treaty. Inflation, of course, is also far lower. So it is not just the desire to stick to the rules, there is something more behind it.
      Personally, I also think that another way to create inflation is quantitative easing, which however is currently forbidden by the EU treaties. This should be changed.

    6. There certainly was a large dose of "internal devaluation" of costs, particularly wages in Germany. A process our own Conservative Chancellor is operating at present in the UK, using the "Austerity Meme". He sees a German style renaissance in the UK; some hope.

      Exporting like crazy is a bit silly, a nation should aim to balance its trade current account at some level. If you export ship loads of BMWs, that's a ship load that your own population will never get to enjoy. What is the point of amassing piles of someone else's fiat currency in a foreign central bank? Balance out those BMWs with importing some Jaguars and Ferraris; Euro for Euro or Pound. (See you at the Nürburgring.)

      Anyway, the large exports are only possible because the rest of the EU is keeping the Euro depressed. Can you imagine where the Deutsche Mark exchange rate would be now. A basic BMW or Merc costing about 30% more in Pounds Stirling than it does now. The Germans would need a lot of productivity improvement to handle that!

      If there is one Country on this planet that doesn't want or need its own currency, it is Germany. The exact opposite of Scotland.


    7. To Acorn:
      "Exporting like crazy is a bit silly, a nation should aim..."

      Sorry, a nation does not "act" or "behave". Only individuals decide and act. German firms do neither force German nor people from other nations to buy their goods. It's a free choice of the people and firms of other nations. The point with imports is o.k. though also a free choice of German people. Since more than 20 years I'm driving Citroen cars. Now, my C6 runs in its 7 year and I was considering to "import" a new one. PSA tells me: production is stopped since Dec. 2012 and they don't have a model that replaces C6. I could wait a year or two or I buy a German car.

  3. I love the morality question - because - I kind of suspect, that greed is a major problem - 'in' and 'for' economies - and so I welcome every sign of a 'lesser greedy people, societies and countries'.
    And as it looks to me that you have identified the German people and Germany as the 'lesser greedy' ones - the 'moral' conclusion is pretty simple. Try to be as 'moderate and frugal' as the Germans or you won't get into heaven!
    -(in a matter of speaking)

    1. OR you could have written a much shorter post - like a frenemy of mine who works on Wall Street once said:
      'Germany needs a housingbubble too'

    2. Except that being "less greedy" in the new normal is sabotaging the rest of Europe. Look at the unemployment and growth rates. They're circling the deflationary drain.

      This seems to be the basic point between those who "get" macro and conservatives who don't because they think with their gut.

    3. 'This seems to be the basic point between those who "get" macro and conservatives who don't because they think with their gut.'

      - or it could be the difference between somebody on the Left who doesn't believe in conspicious consumption - and the machinist of braindead economical growth?

    4. Isn't there a typo there?

      Surely, you mean:

      Try to be as 'moderate and frugal' as the Germans and you won't get into heaven!

      At least, that is what SWL means.

  4. and so about the 'economical' side of the problem - let me point to the decisive fact there too: 'The manufacturing share of GDP in Germany is at 22% according to the World Bank. In the UK and France it's 10%,'
    - and when I was very young I once overheard the 'strategic' conversation of a bunch of Anglo-American geniuses - who came to the conclusion that producing stuff in the 21th century should be left to the 'third world slaves' - and WE - US should concentrate on 'Finance - Tech and Service'!

    Well - If you want it you got it - and then to complain about somebody else who 'stuck it out' is kind of... 'not moral' - don't you think?

    1. The important matter here is that you can't behave as though you still had your own currency. You partake to a monetary union, you need to work with your neighbors, even and perhaps especially, when it means you need to take one for the team.

      The big European project was about making a grand family out of former enemies, to give the whole world an example of moral rightiousness. Instead, it became the lieu of childish fights over who's responsible for what. They're part of a Federation and it's about time they stop talking about "us, Germans, Italians, Frenchmen, etc." and start saying "we, Europeans."

    2. 'The important matter here is that you can't behave as though you still had your own currency. You partake to a monetary union, you need to work with your neighbors, even and perhaps especially, when it means you need to take one for the team.'

      I agree with everything you wrote - that's why I think that Germany even should take over the debt of their neighbors - perhaps in exchange for some 'moral adjustments - where even the rich of the neigbors are asked to pay their taxes?

    3. To reiterate my point in the two long comments further below:

      Right now, EZ nations are not just friends/allies, they are rivals at the same time. An EZ of artificially engineered balance is not worth having. The more competitive need to force the less competitive to catch up to speed. That way the whole EZ gains in competitiveness. Assistance can be supplied, provided it does not slow the competitive nations.

      For now, the EU is not a federal state. And I think it should never be.

  5. I wonder if some of the wage restraint was in part caused by the absorption of East Germany. And of course it was the policy of Schröder.

  6. which reminds me on the old joke - that in a world of insanity - and who would deny that contemporary economics are pretty insane (and amoral) - the saner ones are always the outliers - and no - this is NOT a problem of the saner making.

  7. Dear Sir,

    as I was one commentator to raise concern on the issue of being "too competitive" recently, I feel addressed and therefore compelled to reply:

    "Whatever the reason behind this unusual wage restraint, it is bound to cause problems within a monetary union if other countries do not do the same."

    In my memory, the German public debate at that time was revolving around us trying to no longer being the sick man of Europe, as well as the ascent of China and India. Germany was in crisis, insecure about its future. Even football performances were not good. The mood was one of fear of not much longer being one of the top leading economies of the globe, of being totally eclipsed by China and India in a few years. Partially understandable given record unemployment numbers.

    So the mood was *defensive* in nature. If memory serves me right, it had never been properly considered what wage stagnation (as agreed to by labour unions, not devised by government!) would do to the Euro in public debates. Workers in Germany were simply agreeable to forego pay rises to secure their continued employment. So... let us please be clear that the goal had not been to gain an unfair advantage on other EZ members (as far as public debate goes, at least). Tragically, as Germany started to resurge in 2006, the credit-induced boom in some other countries was about to collapse. As Germany's economy went up, others came down.

    The picture that can be painted then is one of negligence. But it is one of negligence on all sides in the EZ as the other EZ governments did not stop and consider the implications of German policies for the Euro either. What German leadership should have been doing back then is making an effort for the entire EZ to become more competitive vis-a-vis non-European economies. Of course, wage stagnation throughout the EZ would have meant missing the 2% inflation target for the Euro consistently - but retaining competitiveness would have taken preference from a German point-of-view.

  8. (Part 2)
    "I’m normally reluctant to mix macroeconomics with morality, but those that suggest that it should be other countries that have to adjust towards Germany have things completely wrong here. Even if you believe that German real wages had to fall to reduce structural unemployment, Germany has no right to impose the same policy on other countries. A price it should pay for undercutting its neighbours is to experience a period of above ECB target inflation..."

    And here is where we disagree: you regard Germany and other EZ countries merely as neighbors. But erstwhile they are souvereign nations with economies of their own under a common currency. They are not just neighbors, they are also competitors.

    Dear Sir, you say Germany has no right. I raise the question if a currency union which doesn't result in countries pushing each other onwards to greater efficiency is worth having. This is about organizing competition in Europe - not about artificially engineering the EZ economies towards some state of balance or artificial equal prosperity for all.

    To compare with football: would it make sense to complain that Spain had no right to raise the bar with its tiki-taka style of attack for other teams? Or if Bayern München was to simply play faster than some their opponents... would it make sense to claim that it has no right to force their rivals to learn to increase their speed in play also? That is in the nature of competition. That is also why european football is so advanced.

    From a German perspective we cannot wait for the the troubled economies... or at least not too much. I suppose we could try to assist in closing the gap - but only in ways that don't make Germany less competitive, especially in comparison to non-european economies.

    Please understand this: if increased inflation in Germany leads to higher unemployment... this is a plan you cannot sell to the German public. Germans will not accept artificially induced higher unemployment/reduced competitiveness for their country. You are asking Germans to deliberately give up ground that has been hard won. This cannot work. We are not just neighbors, we are also economic rivals (at least to *some* degree). The only solution is that the entire EZ becomes more competitive versus the rest of the world.

    Allow me conclude by saying that I don't consider anything of what I have said in this comment final truth by any means. But for the time being it is my view and, I believe, to a fair degree also the view of German orthodoxy.

    1. While I disagree with your point of view and your conclusions, this is a good summary of the view of the greater German public.

    2. This comment has been removed by the author.

    3. Forcing workers in the rest of Europe to decrease their wages, increases their real indebtedness given that there is minimal inflation. That is going to be painful, and the Germans, as you point out, do not care.

    4. 'this is a good summary of the view of the greater German public.'

      It is only part of the view of the 'greater German public' and both of you might have forgotten a very important view of the younger German public:
      Economics have to have some kind of 'morality' - especially concerning the environment and 'social justice'.

      And then suddenly the anti-social behaviour might be expressed in the constant efforts of monetary economists and monetary policies to stimulate more Inequality?

    5. @ rob sol 13:00
      The decrease in real wages is going to happen either way, the monetarists just hide their intended decrease with more inflation. The cause of this is the downward rigidity of nominal wages, which I also accept. But the logical remedy is to increase inflation throughout the whole Eurozone, not just in Germany with the hope that it somehow spreads across Europe, destroying Germany's relative competitiveness in the process. I wouldn't mind a three or four percent inflation target, but why does Germany need to have more inflation alone except for the unexplained statement that it has to happen.
      The real indebtedness is most easily countered by Eurozone-wide inflation. Ironically, the Germans probably need it least because Germany was one of the few countries without a housing bubble in the 2000s, which is another reason why more inflation in Germany alone is unconstructive. Besides, inflation consists of more than just wage inflation. Quantitative easing or a higher inflation target would debase the Euro and make imports more expensive. That's also going to cause inflation and it will decrease imports and stimulate domestic production and cheapen exports. That's what needs to happen. Destroying Germany's competitiveness through reversing the wage restraint is a strange trickle-down-kind of achieving balance. Economists should demand quantitative easing, a higher inflation target and fiscal stimulus in the depressed countries.

    6. Could you elaborate what you mean in the last paragraph?

      I am even not so sure where you are hinting at in the other paragraph or how this is supposed to relate to the current economic problems.
      The younger German public is totally irrelevant as they are few, have no influence on politics and will not have much influence due to the big babyboomer cohort.

    7. This was for Anon.

    8. 'Could you elaborate what you mean in the last paragraph?'
      It was a reference to Mr. Wren-Lweis idea that Germany should stimulate its economy as 'anything else is the monetary union equivalent of anti-social behaviour.' - and about the younger German public - I doubt it that one of the most influential area in Germany and home of Mercedes Benz and Porsche would have a 'Green' government without it?

    9. and@blub

      I my view 5.) of your list is the key to changing the economic debate in the Anglo-Saxon world.
      The day the General public in the UK and the US will understand that gambling with housing is the most efficient way to commit economical suicide - there will be a sudden and deep understanding of the general German public.

    10. Anonymous13 September 2014 10:03
      Anonymous13 September 2014 10:04


    11. Alexander Sebastian Schulz13 September 2014 13:33

      "why does Germany need to have more inflation alone except for the unexplained statement that it has to happen."

      You are perfectly right. SWL doesn't take the trouble to explain it - probably because he can't.

    12. ''They are not just neighbors, they are also competitors. ''

      this is key for the author of this blog to understand, eurozone countries compete, local politicians are not going to advocate policies seen as against the interest of their own voters. The best you can expect is the ECB trying to get inflation a bit higher, but this is not going to solve the problems. Surplus countries will simply do even more wage reduction to increase competitiveness.
      You might claim: than the eurozone will not work. But before the eurozone, exactly the same problem existed with ESM: countries couldnt compete, they had to exit the ESM. But even with free floating exchange rates, there will be surplus and deficit countries, in fact probably the same countries. This is a problem that can't be solved without full political and fiscal union, but voters dont want this.

  9. Anon of 10:04 says "I raise the question if a currency union which doesn't result in countries pushing each other onwards to greater efficiency is worth having. "

    This is partly true - the idea behind the Single Market, and by extension the currency union, is very largely to promote greater efficiency. However, it is debatable whether a lower share of labour in national income is, or should be, a measure of efficiency. I would tend to argue the contrary: work is not the 'point', pay is. So it would be ethical for German workers to retain more of the value they create, in terms of the German economy alone, as well as moral in terms of the EZ as a whole.

    It is also mentioned that the fiscal multiplier under full employment is less than one. But the point is that the relevant economy - the EZ - is far from full employment. So an increase in demand created by fiscal measures will almost certainly have a positive impact on the eurozone as a whole as well as - surely - creating more benefit for those efficient and hard-working German workers.

    Ultimately, all Europeans benefit from economic activity in neighbouring member states. Benefit both from the extra demand created and from the increased efficiency and competitiveness vis a vis the rest of the world. Membership of a union is NOT a zero-sum game.

    1. A note regarding "work is not the 'point', pay is." While I totally agree and I think it is the point which could be used to convince the Germans, the rule is: economic politics are traditionally "measured" in the German public by the unemployment rate and note by real wages or GDP.

      "Demand management" is dead since the 70s in Germany. One of the reasons for running net exports is seen in a too small inner market to create enough employment. Demand is seen as fixed.

    2. blub13 September 2014 11:49

      "Demand management" is dead since the 70s in Germany.

      And rightly so.

    3. I am really amazed at the misunderstanding of macro here. The ECB is in the business of demand management - that is how it controls inflation. When it cannot, you replace it using fiscal policy. Econ 101!

    4. "When it cannot, you replace it using fiscal policy."
      Of course you do, but this is something the majority of the German public and especially the (economic) media does not believe and tells its audience. There is no real macro-thinking, you are not allowed to "intervene" in the economy.
      I do not know if you speak German but it is quit interesting to see the difference between some of Prof Fratzscher's editorials/newspaper articles, etc. for a German and an English audience. He basically writes a lot more pro supply-side in German since, it seems, he otherwise would be branded as left-wing, never learning, union-friendly idiot.

  10. Most pros and cons have been presented. May I remark that Mrs. Merkel and even the President of the Bundesbank, Mr. Weidmann have stated recently that they would appreciate higher money wages. And wages are rising. At this stage nobody fears inflationary processes except some madman who always fear something.
    The fundamental question is whether the rising money wages will lead to a an increasing price level. Some prices of none-tradeables (flats, houses, etc.) may rise, but many tradeables have become cheaper. So it is not clear at all whether an inflationary process can be aroused and stimulated.

    1. "So it is not clear at all whether an inflationary process can be aroused and stimulated."

      Quite right. SWL has refused so far to explain in detail how he thinks that could be brought about.

    2. Not exactly refused - it is self-evident. If you stimulate the economy, either by monetary or fiscal policy, you raise demand and inflation.

    3. "If you stimulate the economy, either by monetary or fiscal policy, you raise demand and inflation."

      Yes, in a one-commodity world, like texbook macromodels suggest. However, we are living in a multi-commodity world. First, not all supply price curves are rising and, unfortunately, here and there supply curves may decline faster than demand curves rise. The longer an adjustment process is operating the higher the probability that supply reacts.

  11. This is just another way of saying that it is difficult to make monetary policy for desperate nations who share a common currency. Of course it would not be difficult to have done better than the ECB actually did, failing to keep NGDP on track. ECB did not even prevent average EU inflation from falling below 2%, which was their target.

    1. Yes it's an old but received wisdom: monetary policy is like a rope: you can pull, even strangle with a rope, but you can't push with it.

    2. Prof. Wren-Lewis:

      You say: " I’m normally reluctant to mix macroeconomics with morality..."

      In fact, you have been doing nothing else for the last few years. You let your emotions run away with you and then look for some not very convincing macroeconomics to support your moral and pölirical preferences.

      Your lack of self-awareness is truly surprising.

      And as often happens to people blinded by their convictions, they - and you - are incapable to see that others can have quite moral positions. As in the case of German wage restraint: The unions agreed to it to prevent higher unemployment, in other words out of solidarity with people who would otherwise have been on the dole. Or in the question of inflation: It is a tax on the poor (a fact that seems to have been forgotten until Thomas Piketty dug it up again a short time ago). So Germans being against inflation is an act of solidarity with their poor. Why should the poor pay for people who were unable to manage their own affairs?Your answer to that is that refusing inflation is anti-social behaviour.

      I rest my case.

    3. So my emotionally driven 'not very convincing macroeconomics' is little more than arithmetic. If Germany produces below average inflation within the Eurozone (for whatever reason), it will have to experience above average inflation at a later date. The ECB's inflation target is 2%. Those are the rules of the game. You cannot escape having above 2% inflation, except by allowing the rest of the Eurozone to remain in a liquidity trap recession. Nothing you write above disputes that logic.

    4. Prof. Wren-Lewis:

      Thank you for your response. I will come back to it in detail.But I can say right away that I find your arithmetic questionable. Even if it were correct, is it not a morally tenable position to try to postpone the immoral consequences of inflation on the poor for as long as possible?

    5. Mainly Macro15 September 2014 01:33

      Prof. Wren-Lewis:

      Your moral argument boils down to:

      If an evil (inflation) is inevitable, it is wrong, anti-social, greedy etc. to resist it, even for a time.

      Since you are at Merton, you have some philosopher colleagues you can ask at the dinner table what they make of that. They will patiently explain to you that you are committing the gross fallacy of category error. Your moral conclusion does not follow from your assumed facts.

      They may also ask you about your premiss. Inevitability is a prediction. Predictions about the future are only rarely certain, as Aristotle pointed out in his time and Mark Twain expressed in a more witty manner.

      I will come back to your arithmetic later.

    6. Mainly Macro15 September 2014 01:33

      Simon Wren-Lewis writes:

      "You cannot escape having above 2% inflation (in Germany), except by allowing the rest of the Eurozone to remain in a liquidity trap recession."

      That is so sweeping a statement that he needs to explain it in detail. It would seem to mean that macroeconomics' only solution in strong recessions is inflation.

      Is that so? Can macroeconomics offer no other solutions?

      The answer is important, and I hope Simon Wren-Lewis will give it.

  12. Jose Romeu Robazzi15 September 2014 at 12:29

    Dear all, Prof Wren Lewis and readers, this post has been very revealing. Quoting Mr. Wren Lewis: "Even if you believe that German real wages had to fall to reduce structural unemployment, Germany has no right to impose the same policy on other countries". Maybe some German officials have been saying something in the lines "we did our homework, others have to do the same ... ", but in reality, this is not even in question, is it? Germany is not "imposing" anything, the Market reality is. I think the correct argument is the other way around, others don't have the right to impose higher inflation and public spending on Germany, if they don't want to do so ... I think the "imposition" argumento work both ways, and, to be frank, Germans are not imposing anything here ...

    1. How many times - the ECB inflation target is 2%. That is what average inflation in Germany ought to be. So if its less than 2% for some period, it would - if monetary policy was working - be above 3% later. Its so simple.

    2. Mainly Macro15 September 2014 14:19

      "Its so simple°

      Sorry - too simple..

    3. If all countries would inflate at a rate of 2% at the same time, nothing would change within the Euro zone, would it? So what you're really demanding, is a *relatively* higher inflation rate, which, and I have to a agree with Mr. Robazzi, is dishonest.
      I am likewise puzzled how the notion of "Germany imposing austerity" has become so popular. Austerity is mainly imposed by the markets. Germany (and a few other countries like AT, NL, FI) are permanently outvoted and marginalized in the ECB council and the Eurogroup.

    4. And Germany has provided around 330 billion EUR of guarantees, and German savers have already lost several hundred billion EUR due to the very low base rate, which solely serves the crisis states. How is this compatible with Germany being so unbelievable "anti-social" ?

    5. Jose Romeu Robazzi16 September 2014 at 05:55

      The idea that a (too competitive) country imposing bad things to other countries just because they achieve better results makes me very unconfortable. I am not an expert in macro issues, although I have 15 years career in financial markets, I searched for the ECB mandate and found this page:, it looks to me that they are fulfilling their mandate, although there are risks in the downside for inflation, but they are not exactly "doing nothing", are they ? Besides, the idea that left wing economists are trying to defend, that more inflation is good because they allow monetary authorities to "manage" demand more precisely because it is farther away from the zero bound sounds preposterous to me. I live in a country, Brazil, that has followed this idea, our inflation target is 4.5%, and our incompetent government has allowed inflation to stay even higher than that for decades now, the result is not good, we are stagnated, with high inflation, and worker class is indebted in umprecendented levels, public financial institutions are more fragile. The problem with these ideas is that once adopted, they stick, instead of temporary, vested interests makes them permanente, and a few year down the road, you are worse than you started ...

    6. Jose Romeu Robazzi16 September 2014 05:55

      Very good! That is exactly what has been happening in France for about fifty years if not more.

  13. We covered this ground already a while back, about one year ago I should think, when you had a series of posts about France: Germany as an outlier is an idea that was developed there, it has also been developed repeatedly in PK's posts.

    I, who once played down the "asymmetric shock" risks of a monetary union, have finally understood that the key is not in "shock" but in "asymmetric."

    ... way back in the early 1990s, I wrote an undergrad thesis on the possibility of asymmetric "shocks" and I just couldn't think of shocks that would be big enough: a cursory look at the history of Europe pointed to events that were very unlikely to be repeated (decolonization, labour unrest, the end of dictatorships, etc.). What I and others (I was merely digesting other people's work) missed was that the problems would not come from "shocks" in the sense of "a sudden distaste for French baguette" or "a sudden disruption to the supply of German saussage," but rather the problem would be with decade-long divergences that are "endogenous" to the monetary union itself, i.e. investment booms in the tourism industry caused by the process of a fast catch-up made possible by the union.

    Something like this could have been inferred from the Walters' critique, which had a story of endogenous divergence in the period leading up to a union, but it had to do with interest rates and inflation rates rather than investment rates and current account balances: I don't recall anyone explaining how a tourism and housing boom in the south would dislocate the monetary union... Perhaps someone can dig out a visionary article on this?

  14. Müller-Lüdenscheid16 September 2014 at 10:09

    Dear Prof WL,

    what always confuses me is the following. People here in Germany claim that the large foreign-exchange surplus implies that Germany is very competitive; and, honestly, it feels like that. However, if I recall that correctly, a foreign-exchange surplus means that you export capital, which would imply or require being NOT competitive.

    Could you maybe write a blog entry explaining that?


    1. The trade surplus itself does not signify competitiveness itself. Surely, a large surplus requires some form of demand for a country's products and services, however, remember that the trade balance is a comparison of imports versus exports. If a country is uncompetitive and doesn't export much but doesn't import anything at all, there will be a trade surplus.

      However, Germany's companies are certainly competitive on global markets overall. Yet non-German products don't seem to appeal as much to German consumers as vice versa. The result is the trade surplus. The surplus itself then constitutes investment in non-German countries... the aforementioned net capital export. For anything that does not go into consumption of external goods and services eventually ends up as out-of-country investments.

    2. you remember correctly, and your confusion is down to the meaning of "competitive." (google for Paul Krugman, "A country is not a company", should help you understand some of this).

      When they refer to a country, macroeconomists describe "competitiveness" as the relative prices of tradeable goods, or exchange rate: a competitive country is one that runs a trade surplus and a non-competitive one that runs a trade deficit.

      Sometimes economists use competitiveness to refer to an indicator of labor market competitiveness, e.g. unit labor costs.

      Sometimes they talk about productivity and use the word competitiveness in the more journalistic style that we are accustomed to, e.g. Google and Apple are competitive in the sense that they are growing fast, attracting investors, etc.. By analogy journalists (and others) will apply this jargon to countries. A journalist might write that the U.S. has been more competitive than ever in attracting foreign capital (and yet another may write that Asians have been buying up key national interests, it's all a matter of perspective!).

      The latter is confusing because as a matter of accounting identity, a country that runs a trade deficit (non-competitive) also attracts foreign capital (competitive?).

      One way to think of this is: suppose you play a game of flipping a coin and you care only about Head coming up. If you get a good run of Heads, the *pro-Head* press will approvingly write that you have been "competitive" (in the sense of throwing Heads more often than not). Yet, the *pro-Tail* press will report disapprovingly and label you "non-competitive".

      It's a matter of perspective: if you focus on foreign trade (exports), competitiveness has to do with exchange rate and relative labor costs; if you focus on domestic demand (investment, consumption), competitiveness has to do with marginal productivity and interest rates.

  15. ''These are the rules of the game for a monetary union. ''

    Can you please show where this was mentioned in the Lisbon treaty or by which politicians before the euro introduction?
    This was simply not agreed. Either politicians lied about this, or they were unaware. In any case, wage restraints is a traditional method to increase competitiveness for Northern surplus countries, with or without monetary union, and they are not going to give up on this. And what you always ignore is that surplus countries do not care that much about some of the troubled eurozone countries, they care about competitiveness compared to outside the eurzone (something deficit countries seem to forgot).
    as the first poster already said: you are trying to mix economics with politics, but German voters are ONLY going to vote for politicians that improve their lives, not that of troubled countries, and they are right to expect politicians to solely make policies in there interest.
    With all your arguments you assume there must be some kind of eurozone wide macro economic policy because of moral reasons. But you can't introduce these afterwards, German voters will rightly say: why didn't politicians tell us this before the euro introduction. Without fiscal and political union, all your moral arguments will fall on deaf ears in with voters in surplus countries. And assuming you still believe in democracy, you can keep on repeating this on your blog, but no voter will be impressed.

  16. "who strikes first strikes twice"
    this is the reason because they did this wage restrain AFTER the introduction of €,
    when other countries could not devaluate their currency anymore.

    1. Remember: wage restraint was the result of a decentralized process in Germany. It was not imposed by central government. Also, while other EZ countries can't devaluate anymore, they could and still can (in theory) practice wage restraint themselves.

    2. wage restrain was strongly suggested by Haartz reforms and public deficit,
      other countries like Italy could not cut wages like them without cutting Gdp, with Debt/Gdp skyrocketing...

    3. How do Hartz reforms and public deficit make a labour union negotiator cave-in and agree to stagnating nominal wages? Why did labour union members accept it? As I said, it's a decentralized process and not something that has been ordered by Chancellor Schröder.

      And if Italy has debt levels so high that it can't have stagnating nominal wages when necessary, that's the result of prior Italian mismanagement, isn't it? You cannot seriously expect Germany to forego an opportunity to become more competitive versus the rest of the world because Italy's debt levels are too high. It doesn't work like that.



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