Winner of the New Statesman SPERI Prize in Political Economy 2016

Monday, 14 December 2015

A crisis made in Germany

The headline in my latest article for The Independent may seem like a wild exaggeration. But if we are talking about a crisis that impacted on unemployment in the entire Eurozone (except Germany) rather than just the periphery, then I think it is reasonable. It was German policy makers that insisted that the Eurozone embark on general austerity in response to problems in the Eurozone periphery. It was the influence of the Bundesbank and others in Germany that helped the ECB raise interest rates in 2011, and delayed a QE programme until 2015. Those two things together created a second Eurozone recession.

Even if we stick to the periphery countries, the crisis outside Greece would have been a lot more manageable if the ECB’s OMT programme (which allowed the ECB to act as a sovereign lender of last resort) had been implemented in 2010 rather than 2012. It is politicians in Germany that have attempted to declare the OMT programme illegal. And none of this touches on the impact of Germany on Greece. I could also add (although it is not in the article) that if the Eurozone had adopted sensible countercyclical fiscal rules from 2000 the scale of the periphery crisis would have been reduced, and Germany had a large role in the deficit focused rules that were actually adopted.

Of course Germany did not make Greek governments behave in a profligate manner. Of course Germany did not force Irish banks into reckless lending. Their own banks may have helped facilitate both, but so did banks in other core countries like France, and in the UK for that matter. Yet German influence helped magnify the periphery crisis, and Germany was central in turning a periphery crisis into an existential event that impacted on pretty well every Eurozone country, except Germany.     


  1. In the Thursday post you referred to an idea that a country with a flexible exchange rate, does not increase international competitiveness by cutting domestic wages and prices as the exchange rate moves in a way that offsets this change, and appreciates, a basic neutrality proposition.
    Accordingly would you expect a policy of wage increases from minimum wage increases and "living wage" introduction to be accompanied by a decrease in the exchange rate.

  2. Many thanks for these posts. I find them hugely informative and enlightening. I accept that German governing politicians and policymakers deserve considerable criticism, but I'm not sure, if one moves a little beyond the narrow confines of modern macroeconomics within the economic discipline, that they fully deserve the opprobrium that is heaped upon them.

    I would criticise the fetish about achieving the "schwarze null", its mercantilism, the distorting subsidisation of the export sector by imposing cost burdens on other sectors and the defence of closed, rent-extracting service sectors. But I also recognise Germany's attempt (by drawing more and more countries in to its orbit) to position the EU in global economic terms in relation to the US, the BRICS (even if Brazil is in the doldrums and Russia barely justifies its inclusion in economics terms) and the many other medium to large emerging economies. Competitiveness is both an internal EU and an external issue.

    I believe Germany has been torn between this outward-looking stance and an internal EU focus to address the grievous failures of governance in most of the peripheral EU economies. And, unfortunately, seeking to impose a harsh fiscal regime appears to be the only lever it can pull to encourage governing politicians and voters in these badly governed economies to implement the changes that are required to enhance economic performance and social cohesion. Germany expended considerable treasure via its contributions to EU structural, regional, cohesion and social funds to help lift the peripheral economies out of decades of backwardness, ignorance and dictatorship (or quasi-dictatorship as in the case of Ireland). All of these member-states loudly declared their ability to manage their economies within the restrictions of the Euro Zone as a currency, but not really a monetary, union. They weren’t. And Germany was not prepared to expend any more treasure on them than was absolutely necessary. “Fool me once, shame on you…etc.”.

  3. Really good article in Independent. It is really advanced for the average of what is in media in EU, but it is mostly about symptoms then underlying causes.
    For example:
    "The excessive private-sector lending that I have already mentioned led their inflation rates to outstrip the eurozone average, so that when the crisis hit they had become highly uncompetitive."

    Excessive lending as the cause of inflation is an excellent observation. But that also implys that lending increses wages which then increases inflation which is important in equilizing living standards across EU which is desirable and it used to be one of the goals in good times. Now it is on the sidelines and Germanys attempt is to reverse that equalization of standards by blaming public lending instead of private lending.

    National Central banks were fighting such increased private lending by raising rates to private borrowers which is where competition suffers due to debt burden but it can avoid it for a while. But this inflation under higher rates is also the proof that CBs can not control monetary base, at least not in short and medium terms.

    Now the private borrowers in perifery are under higher interest rates of their old debt which is higher burden then in core. Most of the businesses operate under a debt and tougher loans make them uncompetitive since they take larger share of the profit then those with debt with good terms.

    Once de debt deflation starts it is impossible to cut it short without debt forgivness or refinancing under 1% rates just as only those in EU core can enjoy.

    The real cause of crisis is private debt and differences in interest rates of old debts for private borrowers not public debt or inflation diferences. How to preserve living standard gains of perifery is the crucial question?

  4. Not to mention how DE credits were saved using ESM money just a second before banning anything like that for eveybody else when pushing for disfunctional, and ultimately system-breaking, banking union rules.

  5. Simon, I don't really see how "macro-economists" could have added anything of value to the situation. The problem was obvious to "Fiat Currency Accountants". The lack of a federal Treasury in the Eurosystem, basically left the ECB trying to be both fiscal and monetary regulator, without a "sovereign" policy for either.

    The Eurozone problem is now, as it has been since the 2008 GFC; not enough money is available to households to spend. "Troika" austerity diktats are the exact opposite of what is required.

    In fiscal 2009/10, Alistair Darling was running a budget deficit of circa 11%. The UK economy was responding and pulling out of the GFC dive. Osborne replaced him in 2010 and "austeritised" the UK economy, which proceeded to flat-line for three years. (Like it always does at the start of a Conservative government.) The Eurozone is still flat-lining and there is no mechanism for a large fiscal stimulus to be injected into the States that need it.

  6. That's the usual story: the crisis and its aftermath was made in the USA and the UK, and Germany, France, Italy have just tried to provide the best fix they could afford to:

    * The crisis originated in the immediate term in Wall Street and in the City of London, where the "national champion" financial corporations "regulated" by the USA and UK government went catastrophically bankrupt in 2008, causing a worldwide solvency (and only as consequence of that also liquidity) crisis.
    * In the longer term the catastrophic bankruptcy of the "national champion corporations in Wall Street and the City of London was setup by the USA and UK governments with a policy of deregulation and excessive credit loosening as they pursued a "private keynesianism!" policy of serial bubbles.
    * In the specific case of Greece the crisis was cuased in the immediate term when the greek prime minister confessed in the greek parliament that the greek government had used massive accounting fraud to obtain vast amounts of credit.
    * When the crisis happened, Germany, Italy, France and the other smaller economies of the eurozone at unanimity provided 90-95% of the funds via the EU-related "institutions" needed to prevent a catastrophic formal default of the weakest european economies that had been hit by the USA-UK originated crisis, plus a considerable amount of new financing.
    * After the Great Financial crisis the USA and the UK that could have provided directly much more than that to the countries affected by the crisis they created, provided zero direct financing, either to avoid default or as new money, and only a miserable 5% of what Germany, France, Italy and the other eurozone countries provided.
    * In particular even if Greece only needs a miserly $50 billion per year of no-strings-attached fiscal transfers to restore its prosperity to that of 2007-2008, as they seem to be entitled to in the views of many, the USA and the UK have selfishly refused to provide what for them is such a small aid, and have given Greece only 1/20th of what other countries have given and indirectly and on onerous terms imposed by the IMF.

    The history of the Great Financial Crisis and the amounts contributed to the bailout of the weaker EU countries are pretty clear facts.

    The USA and UK gave directly hundreds of millions or several trillions of zero-interest-rate "lending" to their own "national champion" financial corporates that caused the Great Financial Crisis, and a few billions via the IMF to the victims of that crisis.

    Those facts say that the Great Financial Crisis that triggered the sovereign debt crisis was made entirely in the USA and the UK, and its aftermath both USA and UK largely abandoned the victims of the crisis they had made, leaving hanging out to dry the smaller weaker EU countries, despite those countries being long term friends and close allies of the USA and the UK; those countries without the generous help of Germany, France, Italy, etc., would have had it much worse.

    1. Well, yes, by those facts alone you would be right. But more facts show that your reasoning is simply untrue.

      The US provided 15 different central banks $571 Billion dollars during the crisis so they could meet their dollars obligations. That is not counting the amounts that AIG put to foreign banks for their swaps.

      The Federal Reserve learned it's lesson after Lehman. When big problems arose, it took everything that wasn't nailed down and threw it at the problem until it was solved.

  7. I rather agree with this;; comment by Bill Mitchell. The Germans gamed a dysfunctional system that was essentially designed by the French. This fits with the reported advice of Nicholas Kaldor to Mitterand that the EMU was badly designed

  8. SWL's usual fixation.

    Not to be taken seriously.

    1. Anonymous' empty, baseless comments...
      Not to be taken seriously.

    2. @Simon

      The knee-jerk defence reflex of SWL's believers.

      What about reading the comments to his article in the "Independent"?

    3. No knee-jerk defence. Re-read your comment and notice how it lacks any clear, logical reasoning or evidence, failing to explain where SWL is incorrect in his post. Hence my observation of it being an 'empty, baseless comment'. Rather than weak, snide swipes at the individual (SWL), try pointing out and commenting or questioning where exactly he is incorrect, and why. It's not about being a SWL "believer"...this isn't a faith based issue...rather you might engage in the points, facts and evidence cited and check their validity...and if you think he's gone wrong somewhere then explain where and why.
      What about the comments in the Independent? They're not all as vacuous Anonymous comments are they? How many commenters do you think are better qualified, with a more comprehensive understanding of EZ macroeconomics and policy, with greater experience, having spent decades studying, researching and teaching in this field than SWL? The vast majority unfortunately are like the armchair football coaches...people who have scarcely played the game yet somehow know so much more than the players or the coaches.

  9. "Who is responsible for the Eurozone crisis? The simple answer: It is not Germany!"

  10. I don't know. I think the German banks, who are not allowed to sell toxic loans to Germans, sold plenty of toxic loans to Greece and that is why they were the most levered banks in the world. JMO.

  11. Where were the economists during the years leading up to the crash? Where were the ones saying that deregulation was going to far too fast? Where were the ones warning about deindustrialisation?

    Economists and their models could not be trusted then, they cannot be trusted now.

    Germany is doing its bit - 1000000 Syrian refugees - a brave move, fiscally, socially and politically. Posts like this are unhelpful for the tough job facing Merkel - who most certainly does want to help the periphery. We need good policy suggestions on how to help the periphery from the tragic position it is in. Throwing money at problems, however, does not solve them. You need a constructive plan for recovery in the periphery.

    Germany's economy has performed well, on both growth and equity grounds, much better than the country's of its respective critics. I also do not think that German wages need to be raised; its real wages, especially in its export sector, are surely among the world's very highest. Beggar thy neighbour accusations are red-herrings.

    NK (not a German).

  12. Acorn - Bill Mitchell was arguing that Simon Wren-Lewis had forgotten the ECB's Securities Markets Program (SMP). However, it seems clear that the market panics did not improve until OMT, when the ECB did credibly agree to act as lender of last resort, rather than taking those actions as if under duress.

    To that extent, there is an obvious difference between SMP and OMT, which was caused by Germany's pressure on the central bank not to fulfil its role.

    Or, as I commented on that site:


    Surely the point is that given the importance of credibility and sending market messages within central bank roles, with the general anti-lender of last resort (LoLR) sentiment that both the German government and the top people in the ECB were giving off while engaging in SMP, the bond market couldn’t trust that the bank would, act as LoLR when it came down to it.

    Plus, given the evidence of the fact that while SMP was in place, it didn’t stop the spreads growing to unsustainably large levels in self-fulfilling panic… whereas after OMT was announced, the panic stopped, it seems to be clear that it is incorrect to claim that “the reality was that the SMP was virtually indistinguishable from QE.”

    Realistically, despite SMP, until OMT, the Eurozone was at almost monthly risk of hitting a challenge that triggered break up due to market panic about contagion and self-fulfilling prophecies. As De Grauwe & Ji (2013) point out (, OMT can be seen as a success just on the basis that by announcing it, the panic stopped.

    Presumably, the major differences between the two are that with SMP, the purchases were made under duress on the secondary market, while OMT was a credible promise that the ECB would undertake any action necessary (including direct purchases) to support the system."

  13. With hindsight it is easy to construct this argument. But it is unfair to Germany as it ignores the political and historic background to EMU.

    The economic arguments put forward during the 1990s in favor of a monetary union were weak. The euro had to be sold as a political project; ever greater union etc. Many were skeptical (Bundesbank) that EMU could work with such a large group of countries with very different monetary cultures (the opposite of an optimal currency area). What was the point of giving up something that had worked so well for something unknown? So the skeptical German electorate was at least promised a continuation of Bundesbank policies.

    Yet today there are several multi-billion bail-out schemes in place, the ECB is conducting monetary policy in a “whatever it takes” fashion and interest rates for savings accounts are zero. This was never even remotely part of the bargain from a German perspective. It is therefore no surprise that a “limiting liability approach” shaped the German response to the various crises. It was not Germany that somehow ordered and end to credit to Greece or Portugal or Spain: it was the financial markets, a classic “sudden stop”. If the original treaty architecture (no bail out etc.) had prevailed, the game would have been up in 2010/11.

    Back in the 1990s the German trade unions were given a choice: job losses or lower wages. The unions agreed – quite sensibly – to the latter. This was not meant to somehow steal a march on others in the upcoming monetary union. The question was much more basic and fundamental as the employers threatened to relocate on a large scale to Eastern Europe. Luckily the German trade unions are reasonable actors, very different to France and Italy. To blame “Germany” for this prudent course of action is quite frankly ridiculous. I am sure Mr. Wren-Lewis knows that the government is constitutionally barred from interfering in private sector wage negotiations. Somehow German employers and unions should have brokered much higher wage settlements, regardless of the impact on jobs, in order to facilitate the adjustment process of other EMU economies with unruly unions that have belatedly found out that they can no longer devalue. Not very realistic, is it?

    Mr. Wren-Lews wrote in his blog a short time ago that Germany was a “dangerous country” to be in a currency union with. I prefer the term “wrong” to dangerous but it is again a question of perspective of who does not fit with whom. I cannot remember any complaints about sharing a currency with Germany from Austria, Belgium, Luxembourg or the Netherlands, incidentally those countries that had pegged their currencies for many years to the DM without major troubles under ERM. There was constant haggling with the France, Italy and the UK as the exchange rate bands did not work. The UK made the right decision back in 1992 to leave ERM. France insisted on EMU in order to break the power of the DM (Germany’s version of “atomic bomb” according to Mitterand).

    The euro has been a huge mistake. But the various EMU crises are not so much a function of flawed design but an inevitable consequence of membership. The current EMU constituents should not share the same currency. The question is who should not be in.

    The euro has been a huge mistake. But the various EMU crises are not so much a function of flawed design but an inevitable consequence of membership – 16 sovereign countries with very different monetary and economic backgrounds (not much has changed since the 1990s in terms of convergence). It does not make economic sense for many current EMU constituents to share a currency with Germany. Who should not be in is a question of perspective. Germany is unlikely to leave as it sees – correctly – the whole euro project as political and its export sectors enjoys the sweet poison of an artificially low currency.

  14. Simon, in this and a previous post, you seem to view internal devaluation as purely a matter of aggregate demand: Germany gains and the periphery loses. Even on that view, German internal devaluation was surely good for everyone in the bubble years (since it rebalanced overall demand) and only in hindsight turns out to have been bad on the whole, since we now know that the bubble was indeed a bubble and what seemed to be rebalancing has actually had the opposite effect in the longer run. Even if that is true, it seems to me you can't really blame the Germans for that particular turn of events, but to be fair you don't quite say that, either.
    However, it seems to me that wage restraint in fact also has important supply side effects. Just as the models you taught me at Oxford would predict, wage restraint in Germany seems to have permanently lowered the natural rate of unemployment . I reckon periphery countries with notoriously high natural rates of unemployment (esp. Spain) might similarly gain from lower wages, so internal devaluation might end up benefiting the whole Eurozone.

  15. The UK unemployment rate seems to be quite low.

  16. Your article is great because it does emphasize how the wrong-headed ideas of German central bankers and the German economy policy establishment made difficult an adequate policy response to the financial crisis. The German voices in European institutions hindered the use of fiscal policy and monetary policy with the aim of preventing a debt-deflation process and stimulating economic activity. The bad policy response made the crisis worse.

    Unfortunately your article also perpetuates what I like to call the unit labor cost fetish. It wrongly argues that the competitiveness-boosting effects of the wage moderation “ensured that Germany was (and still is) in a far better position than its neighbours following the crisis.” In fact, there is very little evidence in support of the hypothesis that wage moderation was the principal factor behind the export success, neither in the run up to the crisis nor during it.

    Instead, the German export success can be attributed to foreign demand growth and non-price competitiveness factors; many articles argue along these lines. It doesn’t take sophisticated empirical research to cast reasonable doubt on the unit labor cost fetish. Take exports of goods and services in euros from AMECO. On average over 1999-2007, Greece and Ireland recorded export growth rates higher than Germany. On average over 2008-2015, Ireland and Portugal recorded export growth rates higher than Germany. Spain’s growth export growth rate was only slightly below Germany’s in both periods (the growth rates are almost the same). The countries that really do have competitiveness problems are Italy, France, and Finland.

    The wage moderation is not a success model that other countries should emulate. Germany weathered the Great Recession well because:
    a) The household sector and the non-financial business sector entered the crisis with healthy balance sheets. Before the crisis there was a period of deleveraging, rather than a period of debt-financed consumption and real estate investment.
    b) Cooperative capitalism contributed to "internal flexibility", which stabilized consumption and prevented layoffs.
    c) Fiscal policy was counter-cyclical.
    d) Foreign demand growth outside of crisis-ridden Europe helped stabilize exports.

    1. Yes, Enno, the Germans had healthy balance sheets because only 42 percent of them own houses and the rest rent. But they loaned to nations that had ownership rates of around 70 percent like Greece and Spain and Italy. Of course, the Italians and the Greeks and the Spanish look at the Germans who don't own anything and look down on them.

    2. Strong renters' rights and other reasons that explain the low rate of home ownership probably help explain the absence of a housing bubble in Germany. And low rates of home ownership help explain relatively low debt-income ratios. But I doubt that pre-crisis change in home ownership rates explains pre-crisis change in household leverage.

  17. Hi Professor Wren-Lewis,

    Apart from the 'ever closer union' part and the transition - what issues can you see with all members having their own currency but agreeing for shops etc. to trade in Euros as well? E.g. you'd walk into a shop and it would display the current exchange rate and you could pay in Euros with that Exchange rate


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