Angela Merkel

German economic policy, by reducing domestic demand and inflation, has only made it harder for the European economic recovery. Germany can and should stimulate its economy to provide a much-needed boost for the struggling economies throughout the region.

There was an interesting discussion over the weekend regarding economic policy in Germany. It started with a US Department of Treasury report into international economic policy and exchange rates, which upset German officials. The criticism came at an unfortunate time in German/US relations, following the revelations that the US bugged German Chancellor Angela Merkel’s phone.

The report was critical of German economic policy, and rightly so. In Treasury’s view the German government has not done enough to support economic growth in Germany and throughout the eurozone. Although Germany is one of the few euro economies currently expanding, domestic demand remains in a terrible condition.

Since the euro was created Germany has run a large current account surplus, with its export sector driving growth. In 2012 Germany actually ran a larger current account surplus than China. There is nothing fundamentally wrong with running a surplus; after all, countries must run surpluses and deficits for international trade to take place. But for Germany, a surplus this large reflects depressed domestic demand; German firms are still producing goods, but domestically nobody is looking to buy.

With austerity measures in most eurozone economies already depressing growth, we have Germany — which can choose to stimulate its economy — applying the brakes as well. It has helped make a bad situation worse, suppressing growth and stalling the recovery in the eurozone.

For the depressed economies in the eurozone periphery an export-led recovery is their best bet to turn their fortunes around. But for most of them the euro remains too high to create an export-led turnaround because the euro reflects average economic conditions in the eurozone economies. For the poorest-performing countries the currency is too high, and for the likes of Germany the currency is too low. The high German trade surplus is coming at the expense of growth in other euro economies.

However, inter-eurozone trade is actually more important; it is also a bit more complicated. Obviously for inter-eurozone trade the currency is unimportant since they all use the same one. Instead relative wages drive trade in the eurozone.

To paraphrase that article, for a country to reduce relative wages compared to other countries in the eurozone (comparable to a currency depreciation) it requires a country such as Spain to run lower inflation than Germany over a sustained period of time. Eventually this would make German goods more expensive than Spanish goods and boost exports from Spain.

It shouldn’t surprise anyone that this is a long and arduous process. But it would be less difficult if German policy did not put downward pressure on inflation. With domestic demand depressed, it is far from surprising that German inflation has been on the decline. For the health of the eurozone, Germany needs to boost domestic demand and push inflation higher than the European Central Bank’s target of 2%.

The situation in Europe is frustrating, and selfish economic policies by Germany are only contributing to this frustration. Despite the monetary union, the euro remains a set of countries focused internally rather than in the best interests of the union. Self-interest is normally fine, but with highly integrated economies and the lack of a freely moving currency the results have been disastrous. It is time that Germany showed real economic leadership instead of simply expecting more of everyone else.

*This article was originally published at Business Spectator

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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