Austerity Über Alles

BERLIN, GERMANY—Score another one for Angie.

Last night in Brussels, the leaders of 25 of the 27 European Union countries agreed to become more like Germany. Not in so many words, of course. There was talk of spurring growth, creating jobs, and liberalizing trade. But at the heart of the pact was the so-called debt brake.

Modeled on Germany’s own 2009 Schuldenbremse, which imposed a tight cap on federal and state deficits, the debt brake compels participating eurozone countries to keep their structural deficits under 0.5 percent of their gross domestic product (GDP). The 25 countries that signed on—that is, every EU country but non-eurozone Britain and the Czech Republic—are now expected to write language into their national constitutions codifying the deficit limit, with violators to be hauled before the European Court of Justice, which can fine member countries as much as 0.1 percent of their GDP.

The fiscal pact is a major victory for German Chancellor Angela Merkel, who set it as a precondition for more decisive measures to stem the European sovereign debt crisis.

But it’s also of questionable utility at a time when austerity already reigns supreme and growth is what’s really needed to pull Europe out of its spiral. To some European economists, the fiscal pact is a potentially positive long-term step but a distraction from the continent’s more pressing needs: a firewall to eliminate the risk of an Italian default, another rescue package for Greece, and something—anything—to bring down unemployment in places like Spain, where it’s above 20 percent.

To many American economists, the plan looks, frankly, insane. That’s because it goes against one of the main foundations of American economic thinking: the teachings of John Maynard Keynes, who preached expansionary monetary and fiscal policy during times of recession. When the economy is contracting and deficits are increasing as tax revenue drops, Keynes argued, the last thing the government should do is pull money out of the system.

Sure, Milton Friedman’s “We are all Keynesians now” might no longer be strictly true in the United States, but Keynesianism still holds much sway over Democrats and Republicans alike. (When’s the last time you heard a politician of either party say in a recession, “I promise not to take action to create jobs; let’s just ride this one out”?) Not so in Europe, and very much not so in Germany, where Keynesianism is, for all intents and purposes, dead.

“German economics has been mostly purged of Keynesians,” says Sebastian Dullien, a Berlin-based economist and senior fellow at the European Council on Foreign Relations. “Among the top research universities, you might find one or two.”

How did the work of the 20th century’s most influential economist fall so profoundly out of favor in Germany? The answer can be traced to two related historical mistakes that Germans desperately want to avoid repeating: the hyperinflation of the Weimar Republic and the rise of the Nazis.

Loose monetary policy by the European Central Bank, which many economists have called for to ease the vice of debt and recession, could lead to inflation, German leaders argue. And after the disastrous 1920s, when a loaf of bread cost 200 billion marks, inflation is not something Germans are inclined to risk. As for the Nazis, Dullien says, Hitler’s government used essentially Keynesian methods to bring down unemployment—a poisonous precedent for future German governance.

“Intellectually, after the war there was this economic thinking that you shouldn’t do these things,” Dullien says. “The independence of the Bundesbank was enacted at this time: Don’t tinker with economic policy to influence economic growth.”

Instead, the idea is to set tight boundaries for the markets, starting with limits on public spending, but then to allow the economy to rise and fall.

An American debt brake—known stateside as a balanced-budget amendment—has been proposed now and again by Republicans, though it’s run into a recurring problem: Republican presidents tend to run really big deficits. A national balanced-budget amendment has not come close to passing, in part because most American economists think it would be disastrous in times of recession, when public spending helps stimulate demand and put the economy back on its feet. (The forecasting firm Macroeconomic Advisers estimates that with a “hard” balanced-budget amendment, real GDP growth in fiscal year 2012 wouldn’t be 2 percent as currently forecast but rather -12 percent, with unemployment at 16 percent.)

But German officials are sticking to their guns in the hopes that a hard line this time around will prevent another crisis in the future.

“If you go back to the financial crisis, we reacted to the crisis in the same way that we reacted to all of the bursting of speculative bubbles before it, i.e., with more liquidity and more spending,” says a German government official who asked to remain anonymous. “And each time what happened was you ended up with a bit more debt, slightly lower interest rates, and less ammunition for the next time. You get diminishing returns.”

Ordinarily, this would be reasonable logic. But these aren’t ordinary times in Europe. As Paul Krugman noted this weekend, three of Europe’s five biggest economies are or will soon be faring worse than they did during the Great Depression.

Of course, in Germany, the economy is humming along just fine. Unemployment is at its lowest level in 20 years, and GDP grew by a healthy 3 percent last year. Germans can afford to tighten their belts—in fact, Keynesians would tell them that a period of strong growth and low unemployment is the perfect time to do it.

But exporting Germany’s austerity to its less fortunate neighbors is another matter. It may be good politics in Germany, Dullien says, but when it comes to addressing the problems of the eurozone more broadly, the debt brake is—well, I’ll let him supply the adjective.

“I never understood why it’s so widely accepted, and I frankly think it’s stupid,” Dullien says. “The arguments having led to a debt brake are stupid, and I think the design is pretty stupid as well.”

Comments

Probably pointing out the obvious here but it's not the 20s they should be afraid of. It's the 30s.

Of course in Germany, the economy is humming along just fine.... Economists wonder why, and the answer is Boundary Economics.
Establish Sensible boundaries, allow entreprenuerships, stand aside from Fiscal Capitalism, let the Market slide up and down, let the Traders actually trade etc. The Left is simply abhorred against such. The desire to tinker, to guide, to manipulate, to fix things that dont need fixing, is simply too strong.
Folks. History tells us strongly, as in Nature. LET THINGS BE. Enjoy the fruits of your OWN LABOR. Leave the workers work. If you desire to simply stand and watch, then you have to understand that you have to feed your OWN Belly.
End
Semper Fi

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