Bolstering ECB’s credibility

Marcel Fratzscher
Marcel Fratzscher

Marcel Fratzscher

By : Marcel Fratzscher

Germany’s stance toward Europe has become one of rejection and disengagement. Its policymakers deny the euro zone’s crisis-ridden countries a more active fiscal policy; refuse to support a European investment agenda to generate demand and growth; have declared a fiscal surplus, rather than faster potential growth, as their primary domestic goal; and have begun turning against the European Central Bank (ECB) in the struggle against deflation and a credit crunch. On all four counts, Germany is wrong.

To be sure, Germany is justified in rejecting narrow-minded calls by France and Italy for unconditional fiscal expansion. After all, fiscal stimulus can work only if it supports private investment and is accompanied by much more ambitious structural reforms — the kind of reforms that France and Italy are currently resisting. But Germany has all of the leverage it needs to implement the stability-oriented reforms that it wants for Europe. For starters, Germany, together with the European Commission, can compel France to pursue deeper reforms in exchange for more time to consolidate its deficit.

Germany cannot, however, indulge its obsession with supply-side reforms without also pursuing growth-enhancing policies. As Germany knows from its own experience in the early 2000s, the benefits of supply-side reforms — namely, improved competitiveness and higher long-term growth rates — take a long time to emerge. Equally problematic is Germany’s focus on maintaining a fiscal surplus. With projections for German GDP growth this year and next revised downward by more than 0.6 percentage points in the last few months, the government could be forced to initiate a pro-cyclical fiscal policy to achieve its goal, inducing even lower growth at home and throughout the euro zone.

Given that the German economy’s output gap remains negative, the government should be implementing expansionary fiscal policy that targets the country’s infrastructure weaknesses. In this sense, Finance Minister Wolfgang Schauble’s plan to spend an additional $12.5 billion on public investment in 2016-2018 is a step in the right direction. But, at just 0.1 percent of Germany’s annual GDP, Schauble’s scheme looks more like an attempt to quiet criticism from the rest of Europe than a genuine policy shift.

Germany’s fourth policy mistake is its apparent withdrawal of support for the ECB. Over the last seven years, the ECB’s actions have helped Germany’s economy and taxpayers as much as those of its neighbors. Moreover, the claim that the ECB’s purchases of asset-backed securities amount to “toxic loans” that transfer risk to German taxpayers is unfounded; after all, there have been almost no defaults since 2008.

If Germany refuses to take a more reasoned approach, it risks undermining the ECB’s credibility, thereby reducing the effectiveness of its measures. If that happens, the ECB may well be compelled to initiate large-scale purchases of euro zone government bonds through its so-called “outright monetary transactions” scheme. The German government can use its considerable leverage to compel France and Italy to pursue the structural reforms that both countries need, while allowing a growth-friendly demand stimulus to lift the threat of deflation hanging over the euro zone. And it has the authority to bolster the ECB’s credibility and thus its efforts to ensure future price stability and prevent financial contagion.

Europe needs a grand bargain, involving close coordination on structural reforms and fiscal and monetary policy. Germany’s relative economic and political stability, far from enabling it to disengage from such efforts, makes it among the most important protagonists in their development and implementation. The question is whether Germany’s leaders will recognize this before Europe’s economy falls into an even deeper slump.


©Project Syndicate



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