Austerity in Germany – A Keynesian Case

by Andreas Hoffmann*

The positions about economic policies could not have been more divided between Germany and the US during the latest G-20 summit.

On the one side, Barack Obama pushed Keynesian arguments about the need for further stimulus and the danger of austerity measures for economic recovery. On the other side, Miss “No” is back. Merkel promoted consolidation measures to prevent future debt crises and regain markets’ trust in sustainable government finance. And this time Merkel did not cave into US pressure.

I collected some arguments of why this may be a good idea:  

From a free-market point of view, cutting government spending is certainly the way to go when debt financing becomes unsustainable. Less state intervention will give some power back to the market. At the same time, the tax burden does not further increase. Stable government finance can be argued to help building trust in the currency. This could make the risk-averse Germans spend more and save less.

From a Keynesian view, there are mainly three reasons against increased spending in Germany:

1. Private investment demand is up and does not need to be stabilized anymore. There is no ongoing balance sheet recession as most of Germany’s manufacturing companies underwent large scale restructuring in the 2000s and are competitive on world markets.

2. Last year’s fiscal stimulus seems effective as it kept incomes up and people employed. While large spending programs had no effect in the US, the German workers’ subsidy was like a short-term tax cut for companies. A Keynesian could argue that this successfully stabilized the general economy. And as Germany has not seen a domestic consumption boom but rather a production boom prior to the crisis, temporarily subsidizing workers to have them ready to go when the world starts consuming again seems reasonable (from a Keynesian viewpoint).

Just as saving is not being contemplated in the US to reduce the current account deficit, German authorities do not want the export engine to sputter.

3. There is uncertainty about the success of the austerity programs in Southern Europe (similar situation to that of California). If they fail due to declines in private spending, which could depress growth and tax revenues, they may face the deflationary-spiral Keynesians always fear. Then the rest of Europe will jump in to safeguard banks and the economies of the south. The larger the deficits are on both sides, the more problematic is the possible bail-out.

Therefore, from a free-market as well as from a Keynesian perspective austerity is in both Germany’s and the EU’s general interest.

* University of Leipzig and New York University

5 thoughts on “Austerity in Germany – A Keynesian Case

  1. Mrs. Merkel promised to attend to the public finances as does a Swabian housewife to her family’s finances. She is doing her best to live up to that promise, and has suffered poliitcally only in so far as she deviated from it.

    I agree that the Germans at least showed some sense. Bob Litan had a plan for “wage insurance” that accomplished the same thing on the supply side. It would give workers incentives to take a job, as opposed to the present system of unemployment insurance that provides incentives not to work.

    In the U.S., the Treasury might as well have handed the stimulus money over to Bernanke to drop from one of his helicopters for all the effect it has had. Whatever the argument for fiscal stimulus, it is to spread the effects of a downturn around the geenral population and perhaps stabilize nominal demand.

    Those who believe public spending can be the source of sustained growth must believe money spent by the public sector has a higher return than when spent by the private sector. For all those who believe that, I have a bridge to sell them.

    A program of fiscal austerity can have strong positive effects. Three epsiodes come to mind: NZ, the UK under Thatcher and Reagan in the US.

  2. I think the first point is the most relevant – the German economy is growing at a very brisk pace right now and unemployment is falling .

    Tyler Cowen gets it spot on when he says that “according to the German view of the world, these are the good times.”

  3. @Jerry: I agree. I am also not sure whether this workers’ subsidy brought about the effect people like to see it had, but it is hard to tell. More flexible labor contracts could have put firms in the same position and not let them fire workers in the crisis period as human capital is scarce – especially in a countries with shrinking population. And it was not primarly a crisis of the manufacturing firms, so they expected to export more again. Anyways.

    When it comes to demand it was sure better to stabilize the demand of these workers via subsidies than employing some people for weird government projects like digging holes in the ground. If preferences are sort of stable in the short-run, than this should be more successful than changing the income structure.

    @Mario: Starbatty is well known here. He already went to court against the introduction of the euro back in the days. BTW he was Gunther’s dissertation/habilitation supervisor.

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