German economists have to take some blame for Merkel’s slow reaction

These days, the world is stunned by the German reaction to the global financial crisis: While around the world, policy makers rush to pass stimulus packages worth hundreds of billions of dollars and several percentage points of their countries’ respective GDP, the German government is sitting on its hands. While it has passed some measures which supposedly will stimulate demand somewhat, the volumes involved are miniscule. Most observers agree that the measures passed by the German government add up to significantly less than €10bn, some estimates are as low as 0.2 percent of German GDP – an impact you would usually even have a hard time to measure. What is worse, the government does not even seriously seem to consider quick action. Ms Merkel has just recently announced that she wants to take a look at the effects from the measures taken so far only in January before deciding on additional steps. Not only the international press (i.e. the Economist), but also national media is now heavily criticizing the government’s hesitant approach.

All this is even more surprising as all of the important voices in the German economic profession are now calling for a large stimulus package, passed as quickly as possible. Not only the leading research institutes have demanded government investment and tax cuts to be pulled forward, also the Sachverständigenrat (a government-sponsored group of five economic experts) has asked for fiscal stimulus in its recently published annual expertise. One would think that Ms Merkel – herself not an economist – would take on this advise, especially as 2009 is an election year and a deep recession would surely strengthen the opposition parties.

However, if one takes a closer look at the structure of the German economic profession as well as the economists’ past recommendations, Ms Merkel’s reaction look more understandable. First, the recent call for fiscal stimulus by leading German economists comes as some surprise. Over the past decade or so the leading research institutes, basically all leading German academic economists and also the Sachverständigenrat have consistently argued against Keynesian fiscal policy. Moreover, they have not brought forward that fiscal stimulus was not necessary (as would have been true for a boom year such as 2006), but they have usually argued that fiscal policy CANNOT work for principal theoretical considerations. In some of their very recently published economic forecasts (prior to the financial crisis), the research institutes have written that any debt-financed increase in government expenditure would have no effect on aggregate demand as citizens would anticipate that an increase in borrowing today would lead to higher taxes tomorrow and would hence just cut back on private consumption or investment if the government spends more money. A number of economists (including those from the Bundesbank and from the Sachverständigenrat) have even argued with so-called Non-Keynesian effects: According to these arguments, a quick consolidation of the government’s budget (no matter what cyclical situation the economy was in) would lead to an increase in the private sector’s confidence and hence more consumption and investment. While these arguments have been voiced across the world, in no large country have these ideas been as predominant as in Germany. It is hard to come up with more than a handful economists at the country’s 100 or so research universities who at least to a certain extent have argued in a Keynesian tradition prior to the financial crisis. None of them is an international heavy-weight. In the US, in contrast, Keynesian thinking has been used by a number of very well-known economists from Brad DeLong to George Akerlof, Joseph Stiglitz, Robert Solow or Paul Krugman.

These past recommendations are important to understand Ms Merkel’s current hesitation. Ms Merkel has always been good at learning and grasping even complicated issues. However, this approach is extremely complicated by the state of the German economics profession. If Ms Merkel has listened to the economists’ arguments over the past years, one can hardly blame her that she is not very willing to change course quickly. They have not given any explanation why the same policy measures they have considered to be ineffective only a couple years ago should work now. As a natural scientist, Ms Merkel is probably not used that principles change that fundamentally in just a few months’ time. And as German universities have been a monoculture of non-Keynesian economists, she might not have been aware about the deep rift in the economics profession on basic issues such as the effects from fiscal policy.

Add to this the fact that German ministries have been staffed for years with economists educated in the framework of the “Ordnungspolitik”, a German ideology that the government should set the rules of the market but not further intervene, you can see why the German government is sitting on its hands at the moment.

So, if Germany experiences a harsh recession next year because the government is doing too little, too late, German economists are at least partly to blame.

3 Responses to "German economists have to take some blame for Merkel’s slow reaction"

  1. Guest   December 3, 2008 at 11:55 am

    To what extent is Keynesian fiscal spending effective in a country as dominated by exports as Germany? Sounds like a good idea for the German govt to save money, let the rest of the world borrow to allow continued consumption of German goods, Germany should be ahead at the end of the crisis then.

  2. dave   December 3, 2008 at 4:47 pm

    @Dullien: Good comment! It is sometimes frightening to see how Germany debates fiscal stimulus. My favourite is Peter Müller (Ministerpräsident Saarland) who argued for tax cuts after the next federal elections in fall 2009 and called it a stimulus! Sad but true.@ guest: Martin Wolf explained today in the Financial Times why surplus countries have to stimulate domestic demand – through whatever means. Since we face a global financial shock and a slump of aggregate demand, running huge current account surpluses is actually beggar thy neighbor policy, because surplus countries are importing demand. However, if the world economy doesn´t rebalance soon, the next debt and currency crises (in deficit countries) are around the corner, which is certainly not in the interest of the surplus countries.

  3. Guest   December 4, 2008 at 7:54 am

    Not to forget basically all of these “important voices” denied for ages the “American crisis” could have a serious impact on decoupled Germany.Problem is that Ms Merkel is not not moving much because the advisors don´t advise, but because it´s her usual habit.