Professor Erik Jones Talks Germany, Eurozone


BOLOGNA — Relations in the Eurozone grow ever more tangled. Germany is assisting France with its budget and structural reforms while pretending to ignore France’s constant flouting of EU deficit rules.

After recent reports from the IMF, which cut predictions for economic growth in Europe, countries are pressing the German government to invest more to stimulate the European economy. German finance minister Wolfgang Schaeuble brushed off concerns over the region-wide economic slowdown as “nervous, hysterical hyperbole.” Though the government now acknowledges the ongoing economic crisis in Europe, it is still steadfast in its anti-spending policy.

To find out more about the continuing developments, Janae Martin sat down with SAIS Europe professor Erik Jones to discuss the financial saga that is the Eurozone.

How did we get to the point where we have based the fate of the Eurozone on one country’s fiscal policy?

The assumption that you start with is that the first response to the Eurozone crisis is a fiscal response. The reality is that the fiscal response is actually the last response, and that’s probably why we’re in this mess right now. We’ve been focusing all of our attention on the European Central Bank, and the European Central Bank has had to go through a series of contortions from 2007 to the present and is in the middle of a major contortion right now in order to keep the wolf from the door.

What the European Central Bank has been arguing all along is that monetary policy by itself is never going to be sufficient. That means that we have to do two different things. One thing is market structural reform. Market structural reform is like going to the gym. If you think of the European economy as bleeding out right now, going to the gym is probably a good idea, but it’d be better to patch up wounds and go from there. Fiscal policy is like a blood transfusion, so that’s what we’re trying to do. We’re trying to get the governments to understand that they need to stimulate the economy in order to make sure that there’s the kind of employment, investment, and consumption that is going to allow European economic performance to be self-sustaining so that they can pay down their debts.

Unfortunately, the governments are not all agreed that this is the appropriate way forward. The governments that are most enthusiastic about a fiscal solution are those, paradoxically, that are least able to do it because they have very high levels of debt or they have very high rates of interest. They may have very illiquid debt markets, so they could be really tiny countries, and tiny countries aren’t great at fiscal policy. So if you want a country that doesn’t have a high level of debt, that doesn’t have a high rate of interest, and is not tiny, then you have to go to Germany, and Germany doesn’t believe in fiscal policy.

There are a lot of reasons why Germany doesn’t believe in fiscal policy. We’ve gotten to the point now where we have to get the Germans to change their mind, because if they don’t change their mind, then bad things could happen all around, not the least of which is that the European Central Bank is about to shoot its last arrow. After that’s gone, what is going to be the source for market confidence?

From Germany’s perspective, they’re one of the few countries doing well in the Eurozone, so they may see this a confirmation of their stance against fiscal policy. They complain that they’ll be writing the checks to cover the fiscal irresponsibilities of other countries.

Think about this. Let’s ignore the fact that they’re Germans for the moment. Imagine that you could borrow money at a negative real rate of interest. That’s basically not only getting the money for free, but when you pay it back, it’ll be worth less. You could use that money to make an investment that had a positive real rate of return. So the thing that you build today will actually generate revenue over time. If you go to any economic agent and say you can borrow at a negative real rate of interest and invest at a positive real rate of return or you could spend out of current income, spending out of current income doesn’t seem good. Why? Because spending out of current income deprives you of the opportunity to do other things. You’re going to make the money to pay back that investment by undertaking the investment in the first place. We know that because that’s what the two interest rates tell us.

Germany is saying no, we’re going to spend out of current income, so they’re actually taxing people in Germany to pay for roads that will have a positive real rate of return when they could borrow at negative interest rates on the same roads and get a positive real rate of return. As a matter of fact, they’re not building roads because they don’t feel they have enough money in their tax base to pay for them, so they’re missing money for free.  That doesn’t strike me as a sensible posture.

Obviously, they can’t borrow the earth and the sky. We’re not asking them to run deficits that amount to 10 or 20 percent domestic product, but any deficit that they run up to 8 percent of GDP is not going to change the basic economic calculus, negative real rates of interest, positive rates of return. This is what the IMF is saying. They’re saying, Look guys, you have lots of infrastructural investment opportunities out there: it is wrong arithmetically for you not to take advantage of the cost of financing that you have to achieve these investments. And I think the IMF is right.

Obviously, the German Ministry of Finance isn’t bad at math, so what other points are they coming from to counter those arguments?

So there are three different arguments that they make.

One argument, straight out of the mouth of the German finance minister, Schaeuble, is that debt is guilt. In the German language, that’s what the word means. Debt has a negative connotation. I’ve heard many politicians argue about the moral obligation to avoid getting into debt.

What’s fascinating is that if you actually go to the Bible and search for any synonym of debt, you will find that there is no injunction on getting into debt in the Bible. There’s only injunctions against usury and excessive rates of interest, and there’s a requirement  on creditors to provide a seven-year release to debtors. There’s even a requirement in Exodus where creditors have to release debtors from their obligation and also give back any collateral. So the Germans have this very moral view of the universe, which comes out of a Protestant tradition, but is disconnected from the Bible.

Point number two, they have a fiscal notion that is a very strong version of Ricardian equivalence, when you increase spending in the marketplace, and economic agents anticipate that at some point, you will have to increase taxation to compensate for the increase in spending. So they anticipate that in that increase in taxation you get no positive effect from the stimulus you tried to generate because of the market reaction, which is equal and opposite.

The Germans have a very strong form of Ricardian equivalence that’s built into their analysis.

So it’s immoral, and it’s ineffective: we shouldn’t do it. But even worse, it’s counterproductive. This is the third line of argument. In their strong form of Ricardian equivalence, there’s also space for the market to become aligned with the sustainability of national debt dynamics. So they’ll look at it and say, “Not only do we know that you’re going to have to raise taxes in the future, but we also observe that the debt-to-GDP ratio is accumulating in a way that you may not be able to compensate or sustain. We should actually retrench now to prepare ourselves for this horrible future when your debt sustainability dynamics go completely out of whack and you have to overcompensate.”

So it’s immoral, it’s ineffective, and it’s counter-productive, and the Germans say, “Of course, why would we do that?” They want to have a balanced budget, pay down everything, and just not borrow money, which is the most anti-capitalist attitude you could possibly imagine, but it’s deeply baked into the cake.

Can the euro survive without some sort of fiscal union?

Europe doesn’t need a “fiscal union.” What it needs are shared resources to bail out European banks and to shore up (or insure) European deposits. That is a fiscal union of sorts, but it is much less than what people imply when they make the argument about how fiscal union is important.

What about the talks, or standoff, between Germany and France? France is saying, “We’ll cut our spending if you increase your spending.” Germany is saying, “We’ll increase our spending if you cut your spending.”

That’s actually a really fascinating dynamic that has unfolded through various stages of Franco-German partnerships, so this is not the first time they’re having this conversation. As a matter of fact, we can trace it all the way back to the middle of the 1970s, which is the first time that the French actively engaged in this kind of large-scale macroeconomic policy negotiation.

In its present incarnation, what the French are really saying is, “Look, we have these rules that we all signed up to, but let’s be honest, the rules don’t make sense.” The Germans are saying, “But rules are rules: If we let you out of the rules, what are you going to give us in exchange? What are you going to give us as a sign of good faith that this is an exception and not a new rule?” What the Germans don’t want is a new rule that says do whatever you want.

Again, this is straight out of the mouth of Wolfgang Schauble. Germans are very concerned about moral hazard, that they’ll be taken advantage of by the French. That’s why they’re doing these specific offsets. It’s not because there’s any particular logic, but because of the negotiating dynamics, it’s possible to explain that these specific offsets constitute “not being taken advantage of.” They’re the opposite of moral hazard: this is legitimate bargaining. The causal connection between spending in one country and a deficit in another country – it’s symbolically very important. Economically, utterly irrelevant.

That said, what’s happening beneath the surface is probably more important. There’s an interesting conversation that’s been started by the economics minister in Germany called Sigmar Gabriel and the economics minister in France, Emmanuel Macron. They commissioned two intelligent scholars, Henrik Enderlein in Germany, the head of Jacques Delors Institut in Berlin, and Jean Pisani-Ferry who used to be the director of Bruegel in Brussels to come up with concrete reform proposals for France and Germany so that they can go to the gym together and reinforce one another through the process of market structural reform. I think that’s a very valuable exercise, but, again, going to the gym is something that you do when you’re not bleeding. So I think it’s great that they’re doing this, but I think we need to get their economies back on their feet again.

Let’s remember that the German economic debt is not great right now. On the contrary, it’s pretty miserable. So Germany also needs stimulus; they can’t keep patting themselves on the back. They actually have a lot of work to do.

There’s an article in the Wall Street Journal that argues that Germany’s lack of spending is providing some stability in the EU because it’s not running huge deficits. Is there some weight to that argument?

Well, you have to look at current account performance in Europe. Does it make sense for the eurozone, this giant economic entity, to run a current account surplus that’s 2 to 3 percent of its gross domestic product? That’s what Germany’s fiscal austerity and its pattern of fiscal austerity projected into the other countries in the Eurozone is resulting in. It’s resulting in all of these economies producing more than they consume internally and exporting the difference, both goods and capital.

I look at the European economy right now and think, “This is just crazy.” It’s crazy because the only way they’re producing more than they consume is by collapsing consumption. And if they’re investing money abroad, I have to ask, “In what universe does that make sense for a country with twenty-five percent unemployment?” Most importantly of all, who’s on the other side of this transaction? Is China absorbing these exports? I don’t think so; in fact, the Chinese economy is not doing particularly well. So, is it the United States? Do we want the United States to be the world’s consumer of last resort? To be the place that absorbs all the excess production from Europe and their excess capital? It didn’t go so well the last time we did that. I think this is a disequilibrium position that the Europeans are ultimately going to have to reject and come into balance with the outside world.

Interestingly, Wolfgang Schaeuble is very aware of this need for moderation, but he can’t shake the Old World notion that current account surplus equals competitiveness. He refuses to recognize the implications of Europe’s current account surplus. In fact, he denied it existed even though the data are easy to find, and they’re quite obvious.

In that sense, I think there’s still a conversation we have to have with Germany about macroeconomic imbalances that hasn’t taken place. We can’t ignore Germany. We can’t require these other countries to become like Germany. We have to have more balance and more moderation.

Schauble is definitely the major influence German economic policy. But what about other voices in Germany?

The main person in the government is Schauble. In public institutions in Germany, the next most prominent voice, not part of the government, is the president of the the Bundesbank whose name is Jens Weidmann. Weidmann is even more austere than Schauble. The real opposition that everyone’s focused on is called Alternative for Germany: they are a voice that’s even more austere than the Bundesbank. So the problem is not that we have a monolithic view in Germany; it’s that the government view, which we see as extreme, is viewed as moderate both by institutional opposition and by this new political movement that’s emerged on the right of the coalition, which wants Germany to get out of the euro altogether.

What steps can Europe take if Germany doesn’t start spending?

I don’t really know. We are at the end of the line in terms of acceptable monetary policy instruments.  We are probably at the end of the line in terms of effective monetary stimulus as well.  And we have a lot of other problems to manage, including Russia/Ukraine, Syria, Libya, and the like. That is a lot to have on one plate. Without some relief from German fiscal policy, it is hard to see where we are going to get further stimulus for European economic performance. Alas, I don’t think that German fiscal stimulus is really in the cards at the moment.