Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday 26 October 2014

Why the Eurozone suffers from a Germany problem

When, almost a year ago, Paul Krugman wrote six posts within three days laying into the stance of Germany on the Eurozone’s macroeconomic problems, even I thought that maybe this was a bit too strong, although there was nothing in what he wrote that I disagreed with. Yet as Germany’s stance proved unyielding in the face of the Eurozone’s continued woes, I found myself a couple of months ago doing much the same thing (1, 2, 3, 4, 5, 6), although at a slightly more leisurely pace. Now it seems the whole world (apart from Germany, or course) is at it: here is a particularly clear example from Matt O’Brien.

I’m not going to review the macroeconomics here. I’m going to take it as read that

1)    ECB monetary policy has been far too timid since the Great Recession began, in part because of the influence of its German members.

2)    This combined with austerity led to the second Eurozone recession, and austerity continues to be a drag on demand. The leading proponent of that austerity is Germany.

3)    Pretty well everyone outside Germany agrees that a Eurozone fiscal stimulus in the form of additional public investment, together with Quantitative Easing (QE) in the form of government debt purchases by the ECB, are required to help quickly end this second recession (see, for example, Guntram Wolff), and the main obstacle to both is the German government.
The question I want to raise is why Germany appears so successful in blocking or delaying these measures. At first the answer seems obvious: Germany is the dominant economy in the Eurozone. However that is too easy an explanation: while Germany’s GDP is less than a third of the Eurozone total, the combination of French, Italian and Spanish GDP is nearly one half. Now it could be that in the past France, Italy and Spain have failed to coordinate sufficiently to oppose Germany, in part because France has placed a high value on the French-German bilateral relationship. But that seems less of a problem today.

The puzzle remains if we just view these debates as being about national interest, rather than a battle over ideas. Germany is virtually unique in the Eurozone in not currently having a large negative output gap, and having low unemployment. So, you could argue, it is not in Germany’s national interest to allow Eurozone demand to expand, and inflation to rise. But Germany achieved this position because it undercut its Eurozone partners by keeping wages low before 2007. If political discourse was governed by basic macroeconomics, you would expect every other country to be very annoyed that this had happened, and be demanding that Germany put things right by restoring a sustainable relative competitive position through additional inflation.

These last two sentences contain a clue to resolving this puzzle. While nearly everyone recognises the internal competitiveness problem within the Eurozone, hardly anyone describes this as a problem caused by German policy. Instead, as Edward Hugh suggests for example, they believe “Germany’s unit labour costs are low not because Germans aren’t paid much, but because they are very productive, and at the end of the day, despite all the bleating about the current account this is the model other members of the Euro Area (including France) not only need to but are compelled to follow: high pay and high productivity”. I suspect many would agree with that sentiment.

Unfortunately it misses the point. International differences in productivity occur for a variety of reasons, and they are slow to change. The Eurozone’s current problem arises because one country - Germany - allowed nominal wage growth well below the Eurozone average, which undercut everyone else. (This post shows how real wage growth in Germany was below productivity growth in every year between 2000 and 2007.) Within a currency union, this is a beggar my neighbour policy.

In other words, as Simon Tilford suggests, Germany is viewed by many in the Eurozone as a model to follow, rather than as a source for their current problems. (He also plausibly suggests that Germany’s influence immediately after 2010 reflected its creditor position, but he argues that the importance of this factor should now be declining.) Of course in general terms Germany may well have many features which other countries might well want to emulate, like high levels of productivity, but the reason why it’s national interest is not currently aligned with other union members is because its inflation rate was too low from 2000 to 2007. That in itself was not a virtue (whatever the rights or wrongs of why it came about), and so if they had any sense other union members should be complaining bitterly about the German position.

I think the current Eurozone problem makes much more sense if we focus less on divergent national interests, and more on different macroeconomic points of view. The German perspective which sees the Eurozone problem in terms of profligate governments and lack of ‘structural reforms’ outside Germany is utterly inappropriate in understanding the Eurozone’s current position. Yet it is a point of view that too many outside Germany also share.

This is beginning to change. As this Reuters report makes clear, relations between Draghi and the Bundesbank have steadily deteriorated, as Draghi begins to understand the macroeconomic reality. (While I still have problems with the ECB’s current position, set out clearly in this speech by Benoît Cœuré, it makes much more sense than anything coming from the Bundesbank or German government.) Yet, as Simon Tilford notes, it is still not clear whether this will end in a significant departure from current policies, or just more of the minor adjustments we have seen so far.

It may well come down to the position taken by countries like the Netherlands. They have suffered as much as France in following the Eurozone’s fiscal rules to implement damaging fiscal contraction. As Giulio Mazzolini and Ashoka Mody note, “For the Netherlands …. less austerity would have been unambiguously better.” Yet until now, politicians in the Netherlands (and the central bank) appear to have taken the German line that this medicine is for their own good. If they can eat a bit of humble pie and support a kind of ‘grand bargain’ that would see fiscal expansion rather than contraction in the Eurozone as a whole, and a comprehensive QE programme by the ECB, then maybe some real progress can be made. Ultimately this is not the Eurozone’s Germany problem, but a problem created by the macroeconomic vision that German policymakers espouse.


  1. I listened to Ken Livingstone recently praise the German economy as the one the UK should follow.

    And remembering that Livingstone is a Eurosceptic, it seems that an economy with a comparatively large industrial sector is where the hearts of many socialists lie, not in the Anglo-Saxon countries faster shift to the service sector and its implied greater distance between rich and poor.

    I wonder if that is why Hollande went Say's Law, as the choice seemed too much for him and socialism?

  2. It just seems to me that Germany and its like-minded neighbors are doing to Europeans what France (and the UK and U.S.) did to Germany leading up to World War II. France hoarded gold supplies and prevented outflows just as Germany is keeping a lid on its inflation rate. It's making it difficult for its trading partners to adjust.

    1. Peter26 October 2014 09:55

      Where do you get that stuff?

    2. Peter has a point, the position of Germany in the current crisis has some strong similarities with the French position during the interwar years. However I would emphasize France's insistence that Germany pay large reparations after WW1. This was done in spite of German devastation from the war and in the face American opposition and the strong opposition from many public thinkers. Predictably, the problems this caused for Germany had some well-known consequences that came back to bite France in the somewhere.

    3. Germany accepted the principle of reparations when they asked for an Armistice based on Wilson's fourteen points. Points seven and eight stipulated that Belgium and France had to be evacuated "and restored".

      Reparations were calculated on the basis of the enormous damage done in Belgium and Northern France by the German Army. The US was represented on the Reparations Commission.

    4. Dear Jon, if you want to inform yourselve on the matter I strongly recommend the excellent book "Lords of Finance" by Liaquat Ahamed

    5. No, Germany is not really hoarding its gold. Germanys gold supply is on storage at the Fed in New York (~45 %), Bank of England in London (~ 13 %), Banque de France in Paris (~ 11 %). The gold left (only ~ 31 %) is on storage at Germans Bundesbank (in Germany).

      Now guess what´s going to happen, when the German Bundesbank "finds out", that the gold outside Germany "disappeared" AND they publish this information? It will boost the Goldprice through the ceiling.

      Greetings from Germany

  3. Agree:

    The diverging growth of ULC costs as an absolute advantage in international trade for Germany:

    Heiner Flassbeck hinted at the huge gap in competitiveness in the EMU due to German wage-dumping policy four years ago

    1. There is no wage dumping. Wage dumping implies operating at a loss in order to bankrupt competitors. Instead, this is undercutting. Professor Wren-Lewis labeled it correctly.

      Yet it is an act that lies at the heart of capitalism and free market economies.

    2. Millions of individual Germans are working "at a loss" as noted by the fact that ALG II / Hartz IV benefits top up their wages to an "existence minimum".

      The companies that benefit from this subsidy are "wage dumping". Only now is the German govt finally introducing a minumum wage, and that will still leave many working people earning less than the "existence minimum" so receiving state support.

    3. You are introducing another issue here. The question that had been raised prior was the price levels in Germany vis-a-vis its EZ neighbors. If Germany has been undercutting their prices, that is, in my view, a standard action to take within a globalized free market economy.

      My point in the previous comment was that the German wage restraint has turned out to be a *sustainable* policy, therefore the terminology "dumping" seems inappropriate.

  4. I agree that the problems are more ideological than political. Germany has some willing collaborators, the Netherlands, but also Finland. I still think that the inclusion of the German wage restraint hurts your argument. Which industries of their european competitors have the germans priced out of the market? The question of fiscal expansion can be tackled perfectly independent from the wage question.

    1. german wage restraint means that the wages of other countries will have to not just grow less but fall. And this is reason it is so tough for the other members of the EMU to make adjustments.

    2. rob sol26 October 2014 15:16

      "german wage restraint means that the wages of other countries will have to not just grow less but fall."

      Why should that be so?

    3. Indeed, why should that be so? I seriously want to know. What's the mechanism? Which variables in the model are affected? I have the necessary educational background to understand technical explanations but there have been none. Yes, it's tough for other members to make adjustments if Eurozone inflation is low (because of nominal downward wage mobility), but then quantitative easing might work, or just printing money (helicopter money), or fiscal action in the depressed countries, which would my prefered solution. Instead, it has been repeatedly implied that higher german wages will lead to more inflation in the other countries (with the purpose of decreasing those wages). Why? And what happens if german wages stay where they are?

    4. at current german wages, german workers are more productive than workers in the PIIGS at current wages. If German wages were to increase by 10 or 20%, the current wages of workers at the PIIGS would be competetive. That is they now produce 10% less per hour and would produce 10% more per hour if German wages increased by 20%. That would make it more desireable to make goods in the South than in Germany.

    5. They "would produce 10% more per hour if German wages increased by 20%"? Why should rising german wages make workers in the PIIGS countries more productive?

    6. Let me take a stab at answering your question, Alexander.
      In normal circumstances when one country has more inflation than it's trade partner, this will cause a gradual devaluation of the exchange rate that reflects the inflation differential. If one country (Sweden, say) has 2% higher inflation than the UK, the Swedish currency will lose 2% of it's value compared to the British pound each year, holding everything else equal.

      In this simple case the Swedish inflation has zero effect on it's competitiveness.

      In the eurozone however, all the countries share a currency and Spain can't devalue compared to Germany. Therefore, if inflation is higher in Spain than it is in Germany this will make the Spanish economy less and less competitive by increasing the value of it's wages (and thereby Unit Labour Costs) compared to Germany. Because the Eurozone includes both countries that are internationally competitive (Germany) and countries that currently aren't (southern Europe), there will be no natural devaluation towards a level that is appropriate for Spain. The only way for Spain to regain competitiveness is for it to have less inflation than Germany.

      So how does the eurozone deal with an uncompetitive country suffering through an economic crisis? We saw the answer to this in the early 2000's when Germany had an economic crisis and was lacking competitiveness. Germany began to restrain their wages while the ECB lowered interest rates, causing euro-wide inflation to stay at 2%. German inflation fell to almost 0% while southern european inflation went up to 3-4%. This meant a real devaluation for Germany which worked as a stimulus and restored it's competitiveness. The problem is that Germany continued this lucrative which led to a continuous reduction in southern European competitiveness and was an important contributor to the current crisis.

      Today Germany needs to do for southern Europe what southern Europe did for Germany back then and accept some inflation. The only way for southern Europe to regain it's competitiveness inside the Euro is for them to have (quite a bit) less inflation than Germany.

      I'm sorry about the length of this, I don't know how to write succinct explanations.

    7. if wages to germans increase sufficiently, the cost of goods produced by Germans will also increase (though not by the same%) where as the cost of good produced by the PIIGS will stay the same as we are postulating that their wages will stagnate. German workers are not less productive, but the cost of their goods will increase versus the cost of goods produced by workers in the PIIGS. Of course, this process could equally be done by lowering the price of labor in the PIIGS, but labor is sticky on the down-side.

    8. @ Hugo André:

      Thanks for your explanation, you wrote it well. Though it also does not resolve the problem I have with this whole argument. I also think that Germany needs to accept some inflation. Just above I said that I would support quantitative easing and helicopter money. If Germany gave up its resistance to those policies, inflation expectations and inflation itself would soon increase. Then the adjustments in the PIIGS countries would be easier. My problem with the inclusion of wages is that Germany had problems on the world markets before it began this period of wage restraint, so these steps were necessary. Then as you say, the ECB took monetary steps to help Germany (although it was probably a reaction to the early 00s recession, not to specifically help Germany). A parallel action would also be to focus on monetary steps, not to blame Germany for its wage restraint which comes up again and again. I think it is an acceptable policy for Germany to retain its manufacturing sector through wage cuts, it is less acceptable for Germany to completely kill any amount of inflation.

    9. what i would recommend is helicopter money and QE; that way, Germany can still choose any policy that it considers valuable. I am sure that Angela Merkel will fight like a tigress against such a proposal because it will make the PIIGS competitive on wages forcing the Germans to seek another way to keep their economy moving.

    10. @ rob sol:

      This is why, in my initial comment on this post, I asked which industries have been priced out of the market by Germany's low wages. Germany is supposed to give up its market share in manufacturing for the benefit of the PIIGS countries while a solely monetary effort would ease the adjustments there and save Germany's position. Seen in this light, Germany's monetary policy is self-defeating now since more inflation would psuh the talk of low German wages aside.
      Germany's manufacturing sector is highly specialized and very productive, it is what makes this country work. To put the competitiveness of this sector on one level with the PIIGS will not be accepted. Also, which car companies in the PIIGS countries are supposed to take up the market share of german car companies? Or the german chemicals industry?
      Also, as far as I know, german exports go to the rest of the world at a higher rate than to other Eurozone countries, implying that the lack of demand for PIIGS country goods is not related to German wages, but to the wages in the PIIGS countries. Again a lower Euro would help, and this is what Germany is doing wrong, in my opinion. But weakening the Euro by destroying the global competitiveness of the German manufacturing industry is the opposite of good policy. By the way, your comment of 07:16 does not mention adjustments of the PIIGS countries, but your comment of 15:16 did. I guess this is because the question of the German economic model and the question of PIIGS adjustment after the Financial Crisis are indeed independent from another.

    11. I believe one part of the discussion which is often not lead quite "fair" (especially by noted German bashers like Krugman) is, that the discussion always focuses on the (low) German wage growth in the 2000 years.

      This neglects the fact that Germany had lost plenty of competitiveness during the 1990 years, when Eastern German wages had been forcefully adjusted to ca. 80% of the Western German levels regardless of the much lower productivity there.

      This contributed to Germany entering this Millennium as "the sick man of Europe" (coined by The Economist I believe). At least partially the consensually self imposed wage restrictions of the 2000 years were a counter action to wage excesses and loss of productivity in the 90ties.

      In the end I believe the key problem is not wrong doing by Germans or Southerners, but the fact that the EU or EMU is just not a enough integrated and cohesive to work as a currency union. There is not enough migration, not enough willingness for monetary transfers and too much philosophical divide about monetary and fiscal policy: Does not work, will not work I am afraid and everybody who joined to that ill suited union is to blame equally.

    12. ''Today Germany needs to do for southern Europe what southern Europe did for Germany back then ''

      sorry, but this statement is a lie. Southern Europe did nothing to please Germany, Southern Europe followed a policy that they thought was in their own economic interest. As did all eurozone countries, including Germany.
      Now you are expecting that Germany is going to follow a policy that they think (rightly or wrongly, but that doesn't matter, it's their choice) is NOT in their own interest. That is never going to work. As someone else pointed out, we are talking about countries competing with each other, obviously they are not going to do things they believe is not in their (long term) interest.

    13. helicopter money and QE frees Germany from any burden to make adjustment to suit other countries. It would be up to the ECB to decide how best to deal with the economic slowdown of the EMU in general.

    14. @ rob sol:

      Why does Germany need to adjust if these other policies also get the job done? Adjustment is not a goal in itself.

    15. Perhaps I'm misunderstanding you but here we go: Germany already appears to be at full employment so wage restraint implies a larger share of national income going to capital. Since capital ownership is more skewed than wage income this means increased inequality. I suppose my question is whether this is something most Germans would want.

      High productivity in the German manufacturing sector is good for the country to the extent that it increases peoples income. In times of high unemployment, real wage cuts are desirable because they reduce unemployment. If on the other hand a competitive manufacturing sector requires real wage cuts even when unemployment is low, of what use is it to the Germans? Surely, efficient German manufacturing is good only to the extent that it leads to significant real wage increases. In other words it needs to be able to stand without crutches.

      By the way, Antonio Fatas wrote a good post on the subject a little while back:

    16. alexander, Germany will have to adjust to ECB policies; QE and helicopter money will work but will be resisted fiercely by Merkel. I wonder what the ECB will do.

    17. @ Hugo André:

      I think wage restraint was a reaction to the pressures from globalization. If I look at the available world bank data, then the GINI coefficient of Germany was lower than the one in the UK, the USA or a country like Spain or Greece, implying a more equal society. Only the scandinavian countries do better among industrialized countries. The Netherlands do about as well, there was no recent data on France. I think it was a conscious act to prevent the loss of the manufacturing sector to China and other growing countries, India, South Korea, or Brazil. Such a loss would have severely harmed the middle class and increased inequality. The policy was a success and the inequality argument probably doesn't matter.

      @ rob sol:

      Yes, though, of course, the ECB is not an independent factor. Germany has an impact on its policies. But still the question is, how would any kind of ECB policy force higher wages onto Germany? Where's the connection between those two issues?

    18. Anonymous27 October 2014 08:52

      ''Today Germany needs to do for southern Europe what southern Europe did for Germany back then ''

      sorry, but this statement is a lie. Southern Europe did nothing to please Germany, Southern Europe followed a policy that they thought was in their own economic interest.

      Don't be so harsh on Hugo André - he's not lying because he sincerely believes that - even if he is wrong.

    19. Dear Huge Andre, you write:

      "Germany began to restrain their wages while the ECB lowered interest rates, causing euro-wide inflation to stay at 2%. German inflation fell to almost 0% while southern european inflation went up to 3-4%. This meant a real devaluation for Germany which worked as a stimulus and restored it's competitiveness."

      However, this is not what I get to read here:
      In 2000, Germany had an inflation rate of just over 2%, Spain had more than 4%, Greece more than 3.5%. Italy 2.7%. We can go through other years and find little evidence for German disinflation causing the crisis countries to compensate.

      It's not very believable to claim that these inflation rates in 2000 were generous acts of today's crisis countries to offset German deflation. This seems like revising history. A more plausible story is the one that Prof. Sinn tells: crisis countries that made it into the Euro experienced a credit-led boom because of narrowing bond spreads. This caused inflation-rates to go up and if Germany was not going through crisis (in part because of this credit-fueled boom) at the time, the ECB would have found it much harder to reign inflation in. Then credit bubble burst and the crisis countries found that they had foolishly squandered the cheap credit they had been given.

      Another example: When Germany's inflation rate climbed up in 2004, Spain's certainly did not go below 2% in 2004 nor 2005 nor 2006. Shouldn't this have ended the crisis countries' efforts of offseting Germany's previous disinflation?

      I think that it's a myth that today's crisis countries pushed their inflation rate up to help out Germany. As for why this myth is being told, I better leave such speculation to others.

  5. How about Daniel Gros' statement?
    As German I would even have avoided the ESM scam. The euro is the desaster and there is no one-size-fits all politics to fix it.

    1. Prof. Wren-Lewis:

      Please take it as read that low inflation from 2000 to 2007 was a virtue. That you say the contrary is really a death sentence on your blog.

    2. What I meant of course is: an intellectual death sentence on your blog, since of course you are going to continue.

    3. you sound so bitter that someone has an opposing intellectual viewpoint to your own...

    4. Anonymous26 October 2014 18:01

      I am not bitter but astonished, flabbergasted, gobsmacked that someone with SWL's intellectual qualifications should spout such manifest absurdities.. There is a funny side to that, and it reminds one of Alice in Wonderland.

      From 2000 to 2007, inflation in the Euro zone was slightly over 2 %, Germany's on average about 0.5 % lower,


      Can one really maintain that that was so terrible? That needs a lot of explaining.

    5. I can think of a few million unemployed Spaniards and Greeks who might also be feeling a little bitter.

    6. Andreas Paterson27 October 2014 03:34

      "I can think of a few million unemployed Spaniards and Greeks who might also be feeling a little bitter."

      Quite right, too, but not by Germany's fault: It was their own banks' and governments' fault, from which they borrowed or which they elected.

  6. About what should be done I am in wholehearted agreement (who rational couldn't be?).

    However, as an explanation as to why it is not being done, and why the austerians (not all Germans) have got their way, wholly inadequate,

    You can't properly do a post like this without using the word 'law', and going into the detail of EU law. Would it be lawful for the ECB to engage in QE of the kind seen in the UK and US? (A- no, despite some clever arguments to the contrary). Can the fiscal rules be lawfully ignored (A-no). Are these rules easy to lawfully change? (A - no). If they are changed, would they be compatible with the constitutions of some member states, in particutlar Germany? (A-no).

    A lesson for all those who want democratically elected governments to be constrained by fiscal rules. If they don't operate well, they are a bugger to change.

    1. Quite right, except for

      "A lesson for all those who want democratically elected governments to be constrained by fiscal rules."

      The Greek, Italian, and French governments were democratically elected - as was the British one, of which SWL disapproves so much.

  7. Interesting though that with the recent EU budget adjustments, the Netherlands (like the UK) was asked to pay more as their growth was better than expected, while Germany got a reduction in contributions as it did less well.

    I'm also failing to fully grasp your argument for saying German wages 'undercut' those of other countries when in value terms they are higher. I also know there is considerable inefficiency in markets such as Italy which is considered to be a virtue by many Italians, while in Germany the opposite is true.

    There is a German saying "Machen Sie Ihr denken zum danken" which basically means be grateful for what you have (literally, "Make your thinking into thanking").

    1. with all due respect, but there is no such German saying like "Machen Sie Ihr denken zum danken", I as relatively well red native speaker at least never heard of that

      google has some two hits (3 including your comment) coming from some esoteric better/healthier living advice books or something like that, but that does not qualify to make that a German saying

    2. I shall have to take it up with the Bavarian I lunched with yesterday. It was he who told it to me. With respect, Google is not the font of all wisdom, there are many things it does not find. I am old enough to remember many things Google does not list because they existed at a time before the internet became popular and young people stopped reading books.

    3. well, I am also Bavarian, if that adds to the credibility. i don t discount that there is such saying somewhere, but certainly it is not very common, otherwise either I or google would habe came across

  8. Dear Sir,

    you write:

    "But Germany achieved this position because it undercut its Eurozone partners by keeping wages low before 2007. If political discourse was governed by basic macroeconomics, you would expect every other country to be very annoyed that this had happened, and be demanding that Germany put things right by restoring a sustainable relative competitive position through additional inflation.

    These last two sentences contain a clue to resolving this puzzle."

    I agree. These two sentences reveal a divide in goals between people such as yourself and people such as me. You are obviously seeking to establish a pre-defined balance between nations and maintain it. My goal is a group of nations that are competition with each other over favorable business conditions. Including mutual undercutting.

    The term 'undercut' in particular rings a bell with me. One could have the impression that you or the EZ partners think that this is a bad thing. In my view, it is not. In fact, it is the very thing that lies at the heart of capitalism and market economies.

    Without 'undercutting', we might as well return to crafts and guilds.

    You add:
    "[...] Within a currency union, this is a beggar my neighbour policy."

    That depends on your definition of said policy. In my book, it does put pressure on other EZ economies to follow suit (which they did not). And that pressure is a basically a good thing from my point-of-view.

    Furthermore, you write:
    "That in itself was not a virtue (whatever the rights or wrongs of why it came about), and so if they had any sense other union members should be complaining bitterly about the German position."

    Complain as bitterly as a miller in old times would complain about how another miller was undercutting his prices? Well, that is capitalism.

    You finish with:
    "Ultimately this is not the Eurozone’s Germany problem, but a problem created by the macroeconomic vision that German policymakers espouse."

    Please let us not forget: it is a vision that countries have signed up for when they joined the Euro. These countries had de facto endorsed the principles of ordoliberalism and the Bundesbank.

    In contrast to your portrayal, I would postulate that it is highly in doubt whether such endorsement was ultimately more than lip service because people in crisis countries wanted the benefits of a hard currency like the DM but perhaps do not want to pay the price it takes.

    1. Why should countries compete? For the sake of whom?

      The miller does it for his own sake. a country features more than one interest. There is a clear trade-off here and within Germany it came with rising inequality.

    2. Dear Sir,
      you are stating:

      "The term 'undercut' in particular rings a bell with me. One could have the impression that you or the EZ partners think that this is a bad thing. In my view, it is not. In fact, it is the very thing that lies at the heart of capitalism and market economies"

      1. Undercutting is like standing up in a cinema hall to have a better view. It might work unless others decide to do the same, with the result that everybody ends up standing...., beeing worse off.

      2. Undercutting means building up huge current account surpluses while others are willing to incur deficits. Market mechanism would balance this disequilibrum via currency appreciation. But Germany has the Euro.....

      3. Undercutting can lead to severe social unrest and radical tendencies. See what's happening in France with the rise of the neo-fascist Front National.

      Undercutting is an important mechanism for progress in capitalist societies. But do we have to squeeze everything out of it, endangering the pillars of our open society?
      Moderation and responsibilty is needed!

    3. Anonymous27 October 2014 05:44

      Nonsense! Anyway, Germans didn't want the Euro: it was the result of blackmail by the French and Italians - who didn't adapt when they got it whereas the Germans did.

    4. Anonymous27 October 2014 02:32

      "Why should countries compete?"

      Indeed, they don't - it is firms (in exports: of different countries) that compete.

    5. "Why should countries compete?" and
      "Indeed, they don't - it is firms (in exports: of different countries) that compete."

      We must be living in different worlds. In the world I live in, countries want to attract companies and investors to secure employment and tax revenue. And voters elect politicians back into office who manage to do so.

      And, in fact, if countries do not compete, why should Germany aim for a higher inflation rate? To make crisis countries more competitive, you say? Right.

      Countries do compete against each other. You bet they do.

      It seems to me that Professor Simon Wren-Lewis and a few commentators here do not want such competition for Eurozone countries. I do - because without competition we become complacent.

  9. I think understanding of why the German's are taking the policy they do is rooted in the credit bubble and the distortions it created leading up to Eurozone crisis. A proper analysis requires something that is free of model and other pre-conception and carefully follows historical events and is rich in the institutional detail of how the German economy works.

    The people who run the German economy and the intellectuals behind it, believe it or not, are not stupid. I think you would probably have to consider the problems Germany faced with reunification and the difficulties in the wider Eurozone in pursuing monetary union without a proper fiscal framework. We badly need to hear the German point of view which unfortunately is in German and for all sorts of reasons will not make it into Anglo-Saxon English language model and pre-conception heavy neo-classical macro-economic journals.

    1. This is always a problem. Knowledge on the Japanese and Chinese economies, for example, often comes from MIT educated Japanese and Chinese who form part of an international cosmopolitan elite who give a mirror image of the knowledge that was taught to them in the US. (For economics that means putting the issues into familiar but meaningless models.) Really you need exceptional language skills or consult multidisciplinary area specialists who are outside the mainstream profession to real nail the issues. It is a problem for US policy across the board. For example many of the people advising the US government on Middle East foreign policy issues are not people closely connected to local issues and they often support politicians that are cosmopolitan, fluent in English and educated abroad.

  10. In my view the big question is: Is there a macroeconomic vision in Germany? The only one I can think of is to turn the eurozone into a big Germany and I do not think this is a plausible model given the size of the euroarea.

    The German tradition of ordoliberalism has no real macro picture. The picture is to enforce strong competition within your country so that all competitors can conquer export markets more easily. It is the model of a late developer. In this sense the model for the euroarea is to encourage competition between states so that all are better equipped to conquer export markets in the rest of the world. Of course this leads to the "martians problem" which has been described so adequately by Martin Wolf and which cannot work with the euro.

    One factor which should not be overlooked in my opinion is the role of the bundesbank (and its tool, the economics section of the FAZ) and how it has been able to shape the beliefs about monetary policy in Germany. I think that when the euro was introduced and the bundesbank was freed from the responsibility and the consequences of its policy, a culture inside the bundesbank could grow which could take the old anti-interventionary policy ideas too absurd extremes because they did not have to face reality. The introduction of a Carl Menger price can be seen as a symbol of these movements within the bundesbank.

    There was an interesting article about the culture within the bundesbank in the German magazine CICERO several months ago. I think there is real danger that the bundesbank develops into something like a "state within a state", e.g. like the military in the republic of Weimar. This tendency has always been there (e.g. the famous quarrels of Helmut Schmidt with the bundesbank) but it seems to grow even stronger.

    There are also some crazy parts in Weidmann's speeches e.g. where he puts debtors ("Schuldenmacher") close to murderers and people charged with high treason using a quote from Frederik I. who proclaimed a general amnesty except for murderers, high treasoners, blasphemers and debtors. Of course he does not say explicitly that “debtors=murderers” but it is very efficient, very dangerous and very subtle way to argue against active monetary and fiscal policies.

    There is also a certain irony because the archbishop of German conservative monetary policy, Manfred Neumann, who has educated a lot of senior bundesbank people, just recently said in the left "taz" that "the keynesians are right. In essence we need a surge in demand.” ("Die Keynesianer haben recht: Im Grunde braucht es einen Nachfrageschub.")
    (While at the same time saying that the needed public investment should be financed by cutting public officials.)

    1. My understanding of the German economic "model" is a high premium attached to price stability. This is essential given the consensual nature of how prices are achieved - through union-firm-government negotiation. A hard currency and stable interest rates (the price of credit) are also considered necessary for small firms and an efficiently functioning but decentralised financial system. A lot of Anglo-Saxon macroeconomists I believe do not appreciate the reasons many countries value a hard currency. It is not a fear of inflation so much as it reduces uncertainty in and eases transaction, especially for small firms involved in the export trade or require imported inputs but who cannot engage in costly hedging practices. (Funnily most US neo-classical economists including Krugman want it both ways: they say that countries like Germany are obsessed with hard currency at the same time they undervalue them to promote exports!)

      Many of the traits of German economic policy, interestingly, were rooted in post WWII US directed reforms which tried to avoid a repeat of oligopolistic (and inflationary) tendencies in its industrial and financial system.

    2. Of course the focus of this kind of policy is price stability. But this absolutely no concern in the euroarea right now, we are racing towards deflation which would introduce a whole new class of uncertainties.

      In my view the idea of "consensual nature" of wage negotiations today is more a propaganda myth than reality. It is still the case in some industries like the chemical industry are in some parts of the engineering industry but it is not any longer applicable for the whole German economy due short-time contracts, mini jobs, weak unions, …

      While I do agree that deliberately devaluing the currency was never part of the official version of German monetary policy there are lots of dirty secrets which speak a different picture but are not talked about in the public. The bundesbank undermined the ERM by devaluing the currency and it often would buy foreign currency to meet its money supply target which lead to a smaller appreciation of the mark than it would otherwise have had.

      I disagree on the last point. The allies turned the Freiburg liberals because they were the only ones which were not connected to the nazis. And this kind of policy, ordoliberalism, is in essence 19th century liberalism topped up with an independent central bank, a competition bureau and a minimum social safety net.
      The German economic policy after the war is much more ordoliberal than US lead. The US policy at that time was much more keynesian than it is now or than the German policy has ever been.

    3. Great, very informative exchange. Thank you very much!

    4. blub:

      "The bundesbank undermined the ERM by devaluing the currency "

      Details, please. It sounds like a fairy tale.

  11. "The allies turned the Freiburg liberals because they were the only ones which were not connected to the nazis. And this kind of policy, ordoliberalism, is in essence 19th century liberalism topped up with an independent central bank, a competition bureau and a minimum social safety net."

    That's interesting. I would like to know more about that. In fact you make several interesting points which I do not deny are important. I just think a lot of us want this type of discussion rather than being fed the usual liquidity trap arguments with geometric and algebraic gadget.

    I think a lot of worry of allowing increased prices relates to industrial competitiveness. Germany feels threatened by East Asia, who are its real competitors. People tell me that a lot of the industrial base is fast disappearing leaving a super-competitive "higher end". But this sector is dependent on the less efficient industrial sectors who supply various services, parts and often labour as well. Assuming there was an inflationary policy pursued in Germany, rising wages would likely not result in the movement of production to the Eurozone periphery; rather it is likely to close down and be produced in East Asia. Germany would be left with an economy that looked more like Britain's without its advantage of the English language.

    Anyway these are concerns I have heard. I am not an authority.

  12. ''Now it seems the whole world''

    you mean the OUTSIDE world, that is all countries except the creditor nations in the eurozone. Why do you think this is?
    Hint: someone has to pay when things go wrong, and this will usually be creditor nations.
    If US and UK would be creditor nations, I suspect their opinions would be different too.
    It's very easy to take the high moral ground and accuse others, when you yourself do not have to take any risks.

    ''If political discourse was governed by basic macroeconomics''

    As you know the eurozone is not a political and fiscal union, you need to go back to voters in all eurozone countries first if you want this. That is, if you believe in democracy first.

    You can continue these postings, it will not change a thing. If you want to convince the politicians and voters from creditor nations, you have to first take their concerns seriously. And by now you should be well aware of these concerns.
    How about your next posting directly addressing the voters of the creditor nations, and convince them your solution is in their interest and without risks?

  13. Let's take a look at the currency unions USA and UK:
    are you suggesting that it is basic macroeconomics that if wages in let's say Scotland or Florida are too high, and they can't compete, that SE England and New York should increase wages or spend more?
    In these currency unions, the adjustment takes place with fiscal transfers and higher labor mobility. As both are lacking in the eurozone, basic economics would tell you to find the solution here.
    What you propose is some kind of command economy to keep everything in balance.

    1. I think this goes to the core of the issue: The EMU did not then and due to lots of broken porcelain in the meantime does even less so today qualify for an optimum currency area and therefore will - baring a miracle in my opinion - rather sooner than later fail.

      The currency union was rushed by idealist and/or economic dilettantes who either believed in the famous "convergence" (which was always unlikely given the strength of regional identities, strong language barriers and differences in monetary and fiscal policy/ideology) or just had no idea what they were doing to Europe economically, while being focused on other strategic goals.

    2. Anonymous27 October 2014 09:58

      "The currency union was rushed by ... economic dilettantes.

      Quite right. Their names were Mitterrand and Andreotti.Their countries are now paying for their dilettantism.

    3. The Euro is a forced marriage. It is a top-down project which explains why I consider the current EU loathesome. Our elites want to brainwash the huddled masses to forget about their national identities and make them become good Europeans. For power centralization, I suspect.

      A grassroots EU is the only EU worth having.

  14. america works as a currency union in part because people in New York support people in Forida making social security, medicare, and unemployment benefit payments to them. And it is easy for someone in Florida to pack up and move to New York to see employment. It is a whole lot harder for someone in Spain to move to Germany and find work for cultural and for linguistic reasons. And I do not think that the Germans are ready to pay for the social benefits in other countries.

  15. Austerity is having tragic effects in the Southern Eurozone countries. But on other hand while inflationary policy might bring short term relief, I do not see how it will solve the fundamental problems which relate to their industrial structures. There has to be a means of channelling fiscal funds from Germany into productive investment such that it does not lead to a repeat of history.

  16. It seems pretty clear why this has happened. First, it's difficult to explain to non-experts that the answer to a recession is to spend more. Second, it's not in the long term interests of political parties on the right to acknowledge this and the left fears being seen as irresponsible and losing votes if it tries to make the point. Result: shan times abound.

  17. I think you're living in fantasy land.

    The main obstacles to looser fiscal and monetary policies in Europe is the popular sentiment against it, not only in Germany but throughout northern Europe. Europe is simply at too early a stage of its integration to be attempting large-scale fiscal transfers. Europe first needs a sizable federal government. The US didn't attempt its first significant federal fiscal stimulus till the 1930s, 150 years into our integration process. Till then the US states all lived within the strictures of the gold standard. Struggling states were left to deal with their own problems. Many wallowed and some are still wallowing to this day. It's still extremely difficult in US politics to get a specific bailout for any local government.

    If Europe attempted a large federal fiscal stimulus now it would be practically universally understood as a state-to-state transfer. That would tear the union apart. Likewise there are very good reasons for the ECB to avoid trying anything radical here. The obstacle is not the German government - France, Italy, Spain and their allies could easily vote whatever they want through the ECB council over Germany's and all the northern states' objections. But that wouldn't make it wise. Look at the last Europarliament elections. Wake up your dreamy head.

    1. and we are still waiting for the first struggling US state to leave the USA.
      They could have plenty of reasons if you have to believe certain economists:
      no more borrowing in a ''foreign'' currency ($) but borrow in your own currency, just print as much as you want with your own currency, competitive devaluation and no more pesky outsiders bothering you with their morality play.
      All roads to riches, what could possibly go wrong?

  18. you are probably right that germany is not the only obstacle to recovery; the rest of the group could pressure the ECB to take action. i am amazed at the tolerance of the people in the EMU; the US grew 4 % last quarter and has been adding 200 K + jobs per month, and that is looked upon as too little, too late here in the states.

    1. First, don't believe unemployment numbers, the countries with the largest unemployment, also are known for having the largest black economy. Many have an income.

      Second, it may surprise you, but ordinary people in the eurozone like a hard currency. If you as an economist would be serious about the eurozone not working because it's not an optimum currency zone, you would recommend Southern countries to leave the eurozone. This may decrease their unemployment, but devaluation will also increase inflation and decrease living standards.
      This is not what they want! They want jobs + better living standard + hard currency.

      I am amazed that so many on this blog don't seem to understand that there is no popular support to leave the eurozone, in fact there are still countries lining up to join the EU and eurozone! Why, because that's where (they think) the money is!
      No poor(er) country is going to leave the EU or eurozone at free will, and at least they are smart enough to understand that pressuring the richer countries too much will be counterproductive. They will try to push the eurozone to a transfer union, but know they have to do it slowly. Krugman and the author of this blog don't understand the politics of what is going on.

    2. i guess if you are employed and living in the PIIGS, then current policy is reasonable. But if Europeans behaved like Americans, heads would roll.

      The issue is whether stagnation is tolerable because hard currency is more important than increasing the GDP (and thus living standards) and creating more jobs. Or whether the people do not understand the trade-off they are making. Or the fact that people with jobs do not want to take the risk of leaving the EZ.

  19. I recognise that this is a macr-economics column. However, I do wish to point out to all those who advocate QE that it is taxpayers like myself who are burdened with extra debt in order to "stimulate" the Eurozone economy. We small businesses are the Eurozone economy. I do not see how you can possibly reason that my business will be stimulated by loading me with higher taxes.

    1. QE and helicopter money are not tax increases.

    2. for sure, there is no reason to believe that your taxes will be increased due to helicopter money; with QE; it is less certain.

  20. Rob, I beg to differ. Please forgive me if my reply is in too much detail - I know you are a bond trader. I am not.

    Let us say the ECB buys 10 year sovereign bonds from the Italian treasury with a €20 billion face value and with a 4% coupon. It buys them at 2% discount (as would banks during an auction, based on Italy's credit rating and taking into account inflation). The ECB, a monopoly buyer ( who distorts the free market), sells them in the secondary market to banks, hedge funds and pension funds. The bonds offer a massive 6% yield and are oversubscribed as interest rates are close to zero and the market is starved for yield in fixed investments.

    Every quarter, Italy has to pay 4% interest to the current bond-holders. This paid from the Italian central government's account, which is funded by taxpayers. At the end of 10 years, the Italian Government has to pay back the €20 billion to the bond-holders. Once again, this money must come out of the Italian central government budget, which is funded by Italian taxpayers. QE increases the amount that taxpayers owe, or as it is euphemistically stated, increases "public" debt.

    Trust me, I live in Southern Europe. Since my government was bailed out by the Troika, company tax has gone up, VAT has gone up, and our property taxes have gone up by 200%. Our government has to start paying back its bailout loan in 2016. Soon, extra taxes will erode my company's profit margin and push me to the wall. QE spells total disaster. The Germans, who are businessmen, rather than macro-economists, know this.

  21. Travis, i am not a bond trader; i merely am a part-owner of a fund that trades bonds to be accurate.

    We have had QE and a stimulus - though one which Krugman right called not big enough - and which area is doing better, the US or the EMU? Because the ECB buys bonds, it adds to the demand for bonds and thus drives down the price. Buyring your bonds should lower your interest rate and thus stimulate your business. The problem is that the Germans are looking at this episode as a morality play and are not concerned with maximizing production, that you are stuck. Good luck. I button-holed a high official of the one of the finance ministries in the PIIGS, explained this to him, and he had no argument with me except that it would not play in Peoria, that is, people in the ministry would not buy my arguments.

    1. An official in one of the finance ministries in the PIIGS? Who did not immediately agree that everything was Germany's fault? And who said the other people in this PIIGS country's ministry also did not agree?

      You're making this up.

    2. I strongly believe rob sol doesn't know who the PIIGS are.

      Quite a charming misunderstanding.

    3. ''Germans are looking at this episode as a morality play''


      and who is doing better? That depends what measurement you take. GDP growth gives a narrow view, in particular in countries with shrinking populations.

    4. "Who is doing better?"

      *Right now* it looks as if it is the US but the question is if that's sustainable or will collapse 5 years down the road. And the question is also if it's due to QE or rather mopping up the banking sector quickly.

      Historians will be able to decide who did better. All we can today is make educated guesses.

    5. he did not say that it was germany's fault; he merely agreed with me that QE and a stimulus would be beneficial.

    6. who knows what will happen to the US under President Palin

    7. I am not watching the US so much. I think Japan has the potential to become the Stalingrad of QE, so that's the more interesting experiment to observe.

      If Japan falls, perceptions will shift.

  22. So Germany and several other major northern Eurozone members go to great lengths to demand price stability (actually gradual but apparently surprising disinflation, not even a stable rate), and these countries, in general, also prize their high savings rates. But then why, once they've maintained productive, internationally competitive industries and accumulated major savings, according to their model and self-image, do they do such a lackluster and incompetent job at *investing* their funds for a good rate of return on either domestic or international private ventures or domestic or international public investments? They expend so much mental and physical energy on a number of steps in their economic plan, and then they drop the ball on one of the crucial final ones. Baffling!

    1. Yes! Baffling!

      Germans generally deposit their money at a bank, which invests it on their behalf. They rarely buy stocks or bonds themselves. Those professional money managers have many question that need answering but nobody is asking thems, so they won't get answers.

      Germans are terrible investors. They don't understand investing at all, only saving.

    2. "Germans are terrible investors. They don't understand investing at all, only saving."

      What they do not want to do is follow the Anglo-Saxon model which is all about money market capitalism, bankers bonuses, housing bubbles etc.

      This was also forced on the Japanese by the Americans in the 1980s.


    3. Other Anonymous here, the original one in the thread.

      Fair enough. But that's a non sequitur with regard to my original point above--or rather gets things precisely backwards.

      All of Germany's incompetent investing throughout the 2000s was either a) a very Anglo-Saxonish neoliberal underinvestment in public goods or b) a very Anglo-Saxonish funneling (by German-based local to national to global banks) of retail deposits and other savings into finance-constructed vehicles like MBS, coupled with excessive leverage, i.e. undercapitalization from equity.

      There was really no reason for the responsible faction of German elites--and acquiescent, supposedly very savings-conscious ordinary Germans--to go down this incompetent financial path. They could have used all those savings for solid business and public investment and received a very solid to good to great rate of return.

    4. "This was also forced on he Japanese by the Americans in the 1980s"

      How could it have been "forced" on the Japanese? Are you referring to the Plaza Accord negotiations over exchange rates? The Japanese elites mismanaged their economy by the late 1980s.

      And likewise, the German elites, in conjunction with other northern Europeans and also of course the elites of the largest southern Eurozone member states, mismanaged their continental economy by not spending the two decades after the Maastricht Treaty productively refining and improving their political compromises over macroeconomic structure and macroeconomic financial culture. The US--through its government and its global businesses--does do a lot of notable harm in the world. But other major developed areas of the world--above all East Asia and Europe--are big enough boys to accept full responsibility for their own problems and decisions.

    5. When your country is dependent on the superpower for your own security you end up doing what you are told. That could mean either questionable policies that advocate financial deregulation and inappropriate capitalisation requirements for banks, or consumption stimulation to reduce bilateral imbalances, or the financing of, or in the case of the UK, the actual participation in US armed interventions. From an overall political and social perspective the benefits of the peace dividend are probably worth the costs (of course a big debate exists about that).

      But either way for some countries - Germany and Japan - they have unintended economic consequences.

    6. Re: Anon 29 Oct 07:12
      Touché, on Japan at least. On Europe (whether it's the UK or Germany or any other medium-power EU member state), I think you're overstating how necessarily dependent those countries are on the US for security and geopolitical strength. You're out of date by several decades or so; it's no longer the Cold War, especially not the first generation of the Cold War during which European economies were rebuilding. The US and Europe remain in close alliances and collaborate through NATO, but Europe has more options these days including not to be so dependent on the US. In general, it chooses not to; it isn't forced to remain dependent on the US. The UK military intervention example is particularly rich. If the Bush years and the more recent Obama-era interventions showed anything, it's that postcolonial EU member states have a variety of avenues they can take in relation to militaristic US foreign policy and don't have to move in lockstep.

    7. Dear Anon,

      I trust you have been keeping up-to-date on the NSA spying scandals? Which repercussions have their been for the US? Nada, right. The US still runs the show, Europe is dependent on it for security.

    8. "but Europe has more options these days including not to be so dependent on the US. In general, it chooses not to; it isn't forced to remain dependent on the US. "

      Its changing and the US after Iraq and Afghanistan has lost some soft power, but unless there is an independent European defence and foreign policy, not any time soon.

      NATO will remain the bedrock of international security, even with post Cold-War challenges. And it will be the US that calls the shots - for quite some time.

      You may have studied some of the schools of thought in international relations theory - you would know that there is an agreement that multi-polar systems are unstable, so it is not necessarily a bad thing.

  23. Paul Krugman has argued that economists in Sweden who obeyed Model
    against those in the central bank who thought that such devices are not suitable for analysing the real world problems they faced and making decisions that effect people lives have been vindicated.

    As some have pointed out Sweden, among other things, faces a potentially very distorting housing bubble.

    Clearly even Paul Krugman has not learned some very important lessons and the Movement for Post Autism in Economics has a hell of a job to do.

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  25. If Germany is not happy with many of its European partners , then it does have a choice , leave the Euro and the Eurozone . Many Eu citizens are thinking along the lines that Germany lost 2 wars whilst trying to take over Europe , now they are trying via the European Union and finance .

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