The transatlantic divide: How fiscal policy debates differ

Over the past weeks, the economic environment has significantly clouded on both sides of the Atlantic. In the US, odds have risen substantially that the economy will slip into recession. At the same time, the European economy has also developed signs of weekness: Consumption seems to have flat in EMU at the end of 2007 with GDP growth dropping significantly from the still robust paste of the past summer. Odds are that at least some of the EMU economies might come close to stagnation in the first half of 2008. Any large unexpected shock might now be enough for Europe to follow the US into a recession.

Yet, the policy debate on both sides of the Atlantic show a striking difference: In the US, not only George W. Bush is now thinking about short-term economic stimulus. Congress has already looked quite detailed into stimulus options. Fed Chairman Ben Bernanke has even given his advice how to best stabilize the economy using fiscal policy. (RGE monitor has an excellent coverage on this on its main page.)

In Germany in contrast, timid beginnings of the debate have been at been silenced quickly. After the economics minister, Michael Glos, for a short moment discovered the economic downturn as a good argument to further his old idea of tax cuts, he was quickly and publicly called to order by chancellor Angela Merkel in a press conference. Merkel said that given the fact that the overall government budget deficit in Germany is already set to widen slightly from 0 to 0.2 percent of GDP in 2008, any tax cuts would have to wait until 2011 when the government projects the cyclically adjusted budget balance to be in balance. No major politican has voiced open opposition to Merkel so far.

The contrast in the debate is also striking in academics. No economist of national (let alone European) standing has so far proposed any stabilization package. In Europe and especially in Germany, economists still remain extremely sceptical whether fiscal policy at all can be an instrument for stabilization. In a newly published German textbook on European integration (Wager/Eger/Fritz 2006), a whole section is devoting to showing that fiscal policy cannot be used to stabilize the economy with quickly brushing aside any arguments which might propose the opposite. Students are given the impression that there is not even a seriously debate on fiscal policy effectiveness, but that this issue has been solved for a long time. At the same time of publication of this book in Germany, MIT press has published the proceedings of a conference (Kopcke et al.) organised by the Federal Reserve Bank in Boston in which the renowned US economist Alan Blinder presents “the case against the case against discretionary fiscal policy” and other leading economists such as Olivier Blanchard and Chris Sims at least have seriously debated his Blinder’s claims.

At the moment, a number of well-known economists from both the left and the right of the political spectrum have given their advise on a fiscal stimulus package, mostly supporting its passage. Martin Feldstein has recommended legislating tax cuts which come automatically into effect when payrolls drop three times in a row. Larry Summers has also called for stimulus. The Brookings institution has published a whole report on the question how best to design a stimulus package. There seem to be very few voices that seem to feel that the current budget deficit of 2.8 percent of GDP (OECD figures for 2007) could be an obstacle for a stabilization package.

In fact, one sometimes wonders whether the restricted view of German economists might be one of the most important structural impediments of the German economy: German politicians listening to German economists and thus opposing any fiscal stimulus in times of crisis might have seriously prolonged the downturn after 2001. Now, history might repeat itself. In the end, this might not only lead to yet some more years of disappointing growth. In the end, it might even undermine public support for structural reforms, if a bad macroeconomic management destroys the benefits which might arise from a reform course.

Kopcke, R. W.; Tootell, G.M.B and Triest, R. K. (2006), The Macroeconomics of Fiscal Policy, MIT Press, Cambridge, MA.

Wagener, H.-J.M; Eger, T. and Fritz, H. (2006), Europäische Integration. Recht und Ökonomie, Geschichte und Politik, Vahlen, Munich.

This piece has been co-posted at Eurozone Watch.

2 Responses to "The transatlantic divide: How fiscal policy debates differ"

  1. Guest   January 21, 2008 at 7:10 pm

    The same holds for monetary policy as well…

  2. Stefan Collignon   January 22, 2008 at 5:04 am

    There may be a good reason whay European economists and policy makers have “file not found”, when talking about a fiscal stimulus package: they cannot do it! What would matter in the euro area is an aggregate fiscal stimulus, not uncoordinated policies by single member states. If Germany or France or Finland did it on their own, it would only disappear as a marginal stimulus for imports, while the borrowing government would be landed with the full debt burden. At the same time, interest rates would go up und that would take some of the effects away. So, the proper forum for such policies would be the Eurogroup.