Right now the biggest problem for Mario Draghi is not Greece. It is Germany. Last week the president of the European Central Bank hit back at Berlin's criticism of his loose interest rate policies by pointing out that Germany's persistent current account surplus is one of the main causes.
The furious reaction he faced says much about the faultlines in Europe’s economic debate.
Low interest rates and Germany’s current account surplus are the poisonous twins of the euro zone economy. The surplus caused low rates, as Mr Draghi rightly says. But it is also true that low interest rates have increased the German surplus through the devaluation of the euro in the past year. A cheaper currency makes German goods and services more competitive outside the euro zone.
Berlin at fault
The more pertinent of the two interpretations is Mr Draghi’s. By insisting on austerity during the euro zone crisis, and failing to raise investment spending at home, Berlin was instrumental in depressing aggregate demand at home and in the euro zone at large.
The euro zone’s long depression caused a fall in inflation below the target rate of just under 2 per cent. The ECB response has been to cut short-term rates to negative levels and buy financial assets. If German fiscal policy had been neutral, the ECB would have been able to achieve its inflation target and would not have had to cut rates by as much.
Berlin views the current account surplus as a reflection of Germany’s superior competitiveness. This is an economically illiterate view – or rather it deflects from the real problem.
If Germany had its own currency and a floating exchange rate, the current account imbalance would have mostly disappeared. Even in a monetary union, a large imbalance would not matter if the union was politically integrated and had a common fiscal policy. But imbalances matter in the monetary union we have, one without redistribution and reinsurance systems. It is no coincidence Germany rejects these redistribution mechanisms. This is how it maximises its current account surplus. It constitutes an implicit policy goal.
In the long run, I cannot see how this is in Germany’s interests. Wolfgang Schäuble, finance minister, was right to say that low rates are driving voters to Alternative for Germany, an anti-euro and anti-immigrant party. Only it was not the ECB’s fault. AfD comprises mostly well-off older Germans. They want out of the euro because they would benefit from a better exchange rate and higher interest rates – or so they think.
But if both Mr Draghi and Mr Schäuble are right, the consequences are troubling. It tells us that Germany, perhaps more so than Greece, is unprepared for membership of a monetary union.
Under the Bretton Woods system of semi-fixed exchange rates, Germany’s strategy has been to lock itself into a fixed exchange rate system then seek a “real” devaluation through lower relative wages than its competitors. When the system imploded an appreciation of the D-Mark followed.
No correction
The same happened in the exchange rate mechanism, a precursor to the euro created in the late 1970s. But the euro is meant to be forever. There is no longer any corrective mechanism to Germany’s imbalances.
In theory, there is a simple solution. Berlin could cut taxes and raise investment spending. There is a lot of headroom. After years of austerity, the fiscal multiplier – the impact of each euro of deficit spending – is large.
Unfortunately, Germany’s balanced budget rule makes this impossible. More importantly, the electorate and their political representatives do not want it. They want to repay their debt. It is a bad choice but it is a democratic one.
It means, however, that as long as Germany remains in the euro zone the imbalances will not correct themselves
– (Copyright The Financial Times Limited 2016)
