The Germans Have Learned Nothing

by Andreas Hoffmann

Ever since the beginning of the EMU crisis, politicians, journalists and economists have blamed Germany’s “fiscal austerity” for the prolonged troubles in Europe’s periphery. If only the Germans spent more on goods and services, so the idea, the people in the periphery countries of Europe could sell more stuff. Exports would help their economies recover.

The German government, however, is found to engage in fiscal austerity. The recent budget surpluses even seem to annoy people. B. Setzer wrote (mischievously): “Germany has fiscal space even by German standards!”, and she should use it for the good of Europe. But she won’t. P. Krugman adds that Germany’s restrictive fiscal policy was a “drag” on growth in Europe. The Germans seem to have learned nothing from the crisis!

Even if fiscal austerity in Germany were a problem  – a view I do not share – there would be no reason to complain. Fiscal austerity in Germany is a myth. Germany’s balanced budget is not the result of spending cuts or tax increases but declines in borrowing costs. It should not be a surprise to anyone that the European Central Bank’s aggressive stabilization policies have substantially affected borrowing costs for governments in the periphery economies of the euro area. Given the rise in demand for safe euro-denominated assets and increased accommodation by the ECB, German bond prices rallied as well. No austerity was needed to balance the budget.

Let’s look at some data. We see that yields for newly issued German government securities fell by 2-4 percent (depending on maturity) relative to the average yields from 1999-2008, allowing the Ministry of Finance to roll over outstanding debt at lower yields and longer maturities. Lower refinancing costs provided leeway to the German government. The graph below illustrates the corresponding fall of Germany’s annual debt-servicing costs as share of central government expenditure from about 14 percent in 2009 to 6 percent in 2016. At pre-2009 yields, debt-servicing costs would not have declined. Despite falling debt-servicing costs government expenditure (including debt-service) remained constant at around 300 billion euro during this period.

Graph: Debt Service as Percentage of Government Expenditure

Source: Bundesfinanzagentur, Auction results. World Economic Outlook. Our Calculations.

The effective benefits to the government are rising every year as additional low-yield securities replace high-yielding debt securities. In 2011, before Draghi’s bond-buying offensive, the German government effectively saved 7 billion euro in interest rate payments relative to the pre-2009 costs. In 2016, the effective savings were approximately 24 billion euro. The reason is simple. In the meantime, the government has rolled over most of its outstanding debt. Considering all newly issued securities from 2009 to December 2016, the German government’s cumulative savings on debt-service until maturity will be approximately 250 billion euro (compared with the 1999-2008 benchmark yields).

The constant level of government spending is clearly at odds with the notion of austerity policies in Germany. Government expenditure on things other than debt-service has increased since the crisis.

In a way, Germany’s seemingly bright fiscal situation is reminiscent of Spain’s performance until 2006. Following euro introduction, easier access to capital markets allowed the Spanish government to increase expenditure and refinance at lower costs. The statistics suggested good housekeeping as the debt-to-GDP ratio fell and deficits were in bounds. Everybody was happy. Risks of a bursting credit bubble were not considered. When Spanish markets tumbled, government revenues fell dramatically. The Spanish government had it hard to cut back on entitlements and expenditure as GDP corrected downwards. Debt-to-GDP figures increased.

The German government, too, faces a number of factors that might render the fiscal situation difficult in the near future. First, expenses for outstanding debt can hardly be pushed down further. This source to finance additional expenditure in other areas is exhausted. A fall in revenues or increases in spending will no longer remain unnoticed due to financial benefits from the low-interest rate environment. The budget gap forecast already signals a return to deficits because of additional expenditure, e.g., to deal with migration issues.

Second, if Germany’s economic engine starts to stutter and revenues fall, she may see borrowing costs rise and its fiscal situation deteriorate (like in Spain during the crisis). The political situation in Europe and the world is currently highly unpredictable. A return to protectionism, financial repression and the decay of European institutions may undermine growth. And third, if losses from bailout guarantees to other EU member states materialize, the budget will drip with red ink.

Not running deficits in good times should help pay bills when it is necessary. The German economy has performed well, unemployment has dropped to a historic low and tax revenues have been up. Wolfgang Schäuble may be given credit for holding the budget within limits in good times. The Socialists were certainly pushing for more spending.

To be prepared for headwinds, however, the German government should actually engage in austerity measures as long as it’s possible. Even proponents of big government cannot deny that the European Union would be in trouble if Germany was close to default or saw its ratings plunge. But the opposite seems to happen. With the general elections approaching, the major parties have started to promise costly spending programs to attract voters: more subsidized housing, extra policing or increases in spending on infrastructure. Unfortunately, a large share of the German population seems to favor additional, rather than less, public spending.  I’d take that as evidence that Germans have really not learned much from the recent crisis.