A stimulus junkie's lament

One ‘stimulus junkie’ has already had a go at this FT piece by the chief economist of the German finance ministry, but let me add three points. The first is just factual. What is the unusual feature of this recovery compared to previous recessions? It is fiscal austerity. In the past governments have not generally cut spending or increased taxes just as recoveries have begun, but this time they did. Now perhaps the slow recovery and fiscal austerity are not related. But textbook macroeconomics, a large majority of economists, and all the macro models I know say they are. If German officials and economists continue to ignore this fact, they will lose international credibility.

Second, German officials need to be very careful before they claim that recent German macro performance justifies their anti-Keynesian views, because it might just prompt people to look at what has actually happened. Germany did undertake a stimulus package in 2009. But more importantly, in the years preceding that, it built up a huge competitive advantage by undercutting its Eurozone neighbours via low wage increases. This is little different in effect from beggar my neighbour devaluation. It is a demand stimulus, but (unlike fiscal stimulus) one that steals demand from other countries. This may or may not have been intended, but it should make German officials think twice before they laud their own performance to their Eurozone neighbours. If these neighbours start getting decent macro advice and some political courage, they might start replying that Germany’s current prosperity is a result of theft.

Third, they should also think twice before writing that a misguided concern about the impact of austerity “contrasts with much more convincing global action to repair the banking sector”. As this IMF analysis suggests, very little has been done to reduce the effective public subsidy to large banks in the major economies, and hence to avoid the ‘too important to fail’ problem. This is because politicians continue to ignore calls for much larger capital requirements. The financial system may have been partially 'repaired', but it still has the potential to create another global financial crisis.

There is a pattern here. Simple, basic economics is being ignored. That cutting demand or transfers from government reduces overall demand. That a country in a properly formulated monetary union that experiences a period of below average inflation will gain a short term competitive advantage, but it subsequently has to undergo a period of above average inflation to undo that advantage. That equity rather than debt for firms performs an important role as a shock absorber, and financial firms are no exception. It is not too hard to understand why these basic points are ignored. When the interests of politics and money collide with straightforward economics, economics does not stand a chance. If the incentives for getting the economics right are weak, the idea that economics loses out to money and politics is also just basic economics.