Guest Contribution: “It’s Finally Time for German Fiscal Expansion”

Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. A shorter version appeared in Project Syndicate.

As long as the German economy was doing well, as it did during the recovery from the 2008 global financial crisis, there existed a coherent rationale for German fiscal austerity. The national commitment to budget discipline was enshrined in the 2009 “debt brake,” which limits the federal structural deficit to 0.35% of GDP, and by the 2011 “schwarze Null” (that is, “black zero”) policy of fully balancing the budget. Indeed Angela Merkel’s government proudly achieved a balanced budget in 2012 and surpluses in 2014-18.
With unemployment low and growth relatively strong, fear of overheating the domestic economy was a legitimate counter-argument against the other countries that were always urging Germany to undertake fiscal stimulus. They wanted more German spending, which would reduce its current account surplus (a huge 8-9% of GDP in recent years) and spill over into demand that would help other euro members, especially those to the south.
Time for some German stimulus
In any case, overheating concerns are not currently relevant, as German growth has slowed, leading with the trade-sensitive manufacturing sector. The country teeters on the edge of recession: If Germany reports in October that GDP growth in the third quarter was negative as it was in the second, that will qualify as a recession.
Slowing income means slowing tax receipts and a declining budget surplus. Berlin should certainly not take steps to preserve its surplus. To the contrary, it should respond to any slowdown by raising spending and/or cutting taxes. It should particularly raise spending on infrastructure which is in need of maintenance and updating in Germany, even if not as badly as it is in the United States. On the tax side, the government could cut payroll taxes.
The legal constraints of the “debt brake” may limit the size of the stimulus, but they still leave some space – more space than the government budget apparently plans to use. The full “black zero” could be set aside in case of recession. Or it could be re-interpreted to allow deficit spending that goes to investment (especially at the municipal level), while still balancing the government’s current account budget. After all, investment in infrastructure does not constitute borrowing against the future in a true economic sense. That German interest rates are negative (the government can borrow for 10 years at -0.5%) boosts the case for investing in public projects with positive returns, including roads, bridges, and railroads, not to mention 5G networks.
That European interest rates are already so low also means that the European Central Bank cannot do very much more, despite Mario Draghi’s best efforts as he heads out the door. Responding to a slowdown under such conditions is more a job for fiscal policy, as he himself suggested recently.
Pro-cyclical politicians
As Keynes famously said, “The boom, not the slump, is the right time for austerity at the Treasury.”
If Germany allows its philosophical tradition of ordoliberalism to stop it from running a fiscal deficit at a time of recession, its leaders will be placing themselves in a club of foolishly pro-cyclical politicians. They would not lack for company in that group. Historically, many commodity-exporting developing countries have followed pro-cyclical policy — increasing spending and running deficits during a commodity boom, and then forced to retrench when the commodity market falls. Greece did it too, by running big budget deficits during its growth years 2003-08 and then cutting back sharply (under duress from its creditors) in the decade after the euro-crisis hit in 2010. US Republicans have a record of doing it, undertaking fiscal stimulus when the economy is expanding already, as with Trump’s 2017 tax cut, and re-discovering the need to fight deficits when recession hits (1990, 2009).
While some countries like Greece switched from countercyclical spending policy in the late 20th century to a destabilizing pro-cyclical pattern of fiscal policy after the year 2000, others impressively moved in the counter-cyclical direction. To take two examples, Chile and Korea showed pro-cyclical spending on average during the years 1960-1999, but have shown counter-cyclical spending since the turn of the century. Germany could follow the path newly blazed by Korea: after 20 years of surpluses in the overall budget, Korea is now substantially increasing spending to offset slower economic growth. [So could some others with fiscal space, like the Netherlands.]
Yes, long run fiscal responsibility is still warranted
Fiscal policy broadly should be guided by a number of goals in addition to counter-cyclicality. One of them is a long-run path of sustainable debt. One can recognize the mistake of excessive austerity in some countries in the last recession without letting the pendulum swing to the position that countries can run debt without limit, as some observers now give the appearance of believing.
Governments should always check whether their debts are getting too large, even when real interest rates are negative. Many a country has pursued a fiscal path that looked sustainable when the interest rate was below the GDP growth rate, only to find itself trapped by unsustainable debt dynamics when conditions suddenly changed.
One can sympathize with the much-maligned German attitude. Ahead of the 1999 creation of the euro, German citizens had been skeptical of the assurances provided to them in the form of the Maastricht fiscal criteria and the “no-bailout clause.” Their skepticism proved prescient. They make the point that the 2010 Greek/euro crisis would not have happened if Greece after joining the euro had maintained the fiscal discipline called for under the Stability and Growth Pact and had followed the German lead in reforming labor markets (2003-05) and keeping unit labor costs in check.
But to avoid a path of exploding debt/GDP ratio does not require avoiding all deficits at all times. There is a lot of territory in between those two extremes.

Of course it matters how one spends the money
Other critical functions of fiscal policy involve the composition of spending and taxes. Both of those levers can be used to address environmental goals, for example. A renewed German commitment to achieving the goals agreed at Paris for reducing carbon emissions by 2030 is seen as a battering ram against the schwarze Null. Indeed, on September 20 the government announced spending worth some 54 billion euros to cut emissions. In the US, it would be called a Green New Deal.
Spending on such priorities as energy and environmental research can be useful. But in truth, getting serious about carbon and other environmental goals doesn’t have to mean larger budget deficits. Elimination of fossil fuel subsidies and raising taxes on emissions or limiting emission permits and auctioning them can strengthen the budget, as would have been appropriate at the peak of the US and German business cycles. Or the resulting revenues can be redistributed to achieve other goals such as to help the left-behind median household, who may live in the US Midwest or the eastern lander of Germany. The important point for climate change policy is to get the price of carbon up. Doing so is orthogonal to an intelligent choice between fiscal expansion and fiscal austerity.
That choice should be based on the countercyclical criterion and the sustainability of the debt. The US has made some wrong choices, cutting taxes for the rich at the peak of the business cycle. Germany should not make the symmetric wrong choice by preserving its budget surplus as it risks sliding into recession.

This post written by Jeffrey Frankel.

28 thoughts on “Guest Contribution: “It’s Finally Time for German Fiscal Expansion”

  1. pgl

    “The unemployment rate declined to 3.5 percent in September, and total nonfarm payroll employment rose by 136,000 … The labor force participation rate held at 63.2 percent in September. The employment-population ratio, at 61.0 percent, was little changed over the month but was up by 0.6 percentage point over the year.”

    Wait – the payroll survey indicated only 136 thousand new jobs but the household survey indicates that the employment to population ratio rose from 60.9% to 61.0%? What gives? Oh yea – the household survey had employment growing by 391 thousand.

  2. pgl

    Normally one might ask why use fiscal stimulus to stimulate aggregate demand if monetary stimulus can be used but as Jeff points out the ECB has pushed monetary stimulus to the limit:

    ‘That European interest rates are already so low also means that the European Central Bank cannot do very much more, despite Mario Draghi’s best efforts as he heads out the door. Responding to a slowdown under such conditions is more a job for fiscal policy, as he himself suggested recently.’

    As the ECB lowered interest rates on German bonds below zero, we got Euro devaluation, which helps the rest of the Euro zone with higher net exports. But here in America, the Euro devaluation sent that MAGA wearing Traitor in Chief into a whole bunch of twitter rages. Of course Trump is now taking to the twitter to whine about impeachment as he asks China to dig up dirt on Biden. So at least Draghi can have a little peace!


    The problem of German economics runs much deeper than factual observations of its slowing economy.

    The schwarze Null objective commits Germany to neglect the aggregate demand function which is fundamental to the Ricardian economics, as Keynes pointed out. The completeness of the Ricardian victory in Germany is not a mystery. It is due to the suitabilities in the doctrine to the environment into which it is projected, viz., fiscal discipline as virtue in itself regardless of the consequences. That its practice is austere and often unpalatable lends it virtue.

    That it can explain much social injustice and apparent cruelty as an inevitable incident in the scheme of progress, and the attempt to change such things as likely on the whole to do more harm than good, commends it to authority. That it affords a measure of justification to the free activities of the individual capitalist, attracts to it the support of the dominant social force behind authority. That it evinces the moral superiority of German discipline gives it popular appeal.

    But although the doctrine itself has remained unquestioned by German economists, its signal failure for purposes of scientific prediction has greatly impaired the prestige of its practitioners. German economic leadership in the EU has been a failure for more than a decade and millions of Europeans have needlessly suffered as a result. Brexit will be its legacy.

  4. Steven Kopits

    “It should particularly raise spending on infrastructure which is in need of maintenance and updating in Germany…”

    Why? Is infrastructure in Germany in bad shape? It wasn’t when I was there last. Germany’s 15-64 age group is forecast by the OECD to decline by 8.1% to 2030. Why would one need more roads or other infrastructure? Has Germany been skimping on maintenance? That’s not very German.

    Why would you feel a need to stimulate an economy with 3.1% unemployment and a workforce declining by almost 1% per year? What unemployment rate are you targeting? Isn’t the most likely scenario that of Japan, with weak economic growth and shallow recessions accompanied by essentially full employment?

    “…Elimination of fossil fuel subsidies…”
    Have you ever filled your tank in Germany? I can assure you, you will have no sense that you’re being subsidized. As for electricity, Germany already has some of the highest rates in the world. Shouldn’t a goal be to cut the price of electricity to increase German competitiveness?

    Once again, we have an economic analysis utterly oblivious to underlying demographic trends.

    1. Menzie Chinn Post author

      Steven Kopits: Why yes, I’m quite sure Jeff has been there recently; and I was living there for 2 months just a couple years ago (while at ECB). Infrastructure is sure wanting relative to where it was 20 years ago (not relative to US).

      Any standard model (e.g., Chinn-Prasad, Chinn-Eichengreen-Ito, Gruber-Kamin, IMF EBA) would take into account demographics, and still Germany’s an outlier. You really should read some actual academic work before spouting off.

      1. Steven Kopits

        Really? So you’re saying Jeffrey has done a demographic analysis of Germany? Let’s see it.

        If I understand correctly, you’re thinking that Germany should be goosed with, say, tax cuts, as Jeffrey proposes. At 3.1% unemployment? You must have been a huge fan of the Trump tax cuts, as US unemployment was 4.1% at the time.

        But, go on: Tell me how you stimulate an economy effectively at full employment.

        1. Menzie Chinn Post author

          Steven Kopits: You write “Really? So you’re saying Jeffrey has done a demographic analysis of Germany? Let’s see it.” Truly, your hubris in the absence of knowledge is astounding. I didn’t say he’d studied specifically Germany; I asserted that he was familiar with the inclusion of demographics in the modeling of the current account. Look at this 1986 paper (the national saving investment correlation implies current account behavior, if you understand national income accounting).

          Formerly, Frankel was head of the International Finance and Macro program of the NBER; as such he saw all the working papers distributed under that program — including Chinn-Prasad and Chinn-Eichengreen-Ito NBER WPs, which incorporate demographics.

          A fiscal stimulus at near full employment would likely manifest mostly in a smaller current account surplus — that is the objective.

          1. Steven Kopits

            Why do you want a smaller current account surplus? That’s not an objective. Higher GDP growth, higher employment, those are objectives. Other than President Trump, does anyone care about current account surpluses?

            If you stimulate an economy materially at full employment — and we discussed this at length in the case of the Trump tax breaks — you’ll get a modest boost to GDP which fades after two or three quarters, a deterioration in the current account as you point out, no impact on trend employment growth, and some debt you have to repay, plus very possibly a structural deficit (outlay) you just built into your budget. Germany has the fourth lowest unemployment rate in the whole OECD, second lowest in the EU. If Germany needs fiscal stimulus, doesn’t every country in the OECD?

            And by the way, perennially weak Japan has the second lowest unemployment rate in the OECD at 2.4%. Shouldn’t we stimulate that, too, given how tepid their GDP growth has been?

            Again, let me ask you: What are you trying to stimulate? A reduction in the current account is not a legitimate objective of itself, unless you are suggesting that the Fed or the US Congress should set explicit goals for the US trade and current account deficit, a la Trump.

          2. Steven Kopits

            That’s a nice paper, Menzie. Is it relevant to our conversation?

            I have never heard of taking a current account balance approach to stimulating a full employment economy. Now, you could argue that reducing Germany’s current account could be good for, say, Greece or Spain, but I don’t think that’s what we’re talking about here.

            But, go ahead, explain to me the current account approach to fiscal stimulus in a full employment economy.

          3. Menzie Chinn Post author

            Steven Kopits: Redistributing aggregate demand can make the entire eurozone closer to full employment, make the banks less collateral-constrained, and hence make all of Europe more productive. And right now, Germany is contracting, so fiscal stimulus wouldn’t be a bad thing; and we know (at least in the academic literature) that infrastructure investment is the most stimulative of all types of spending, in both the short and long run.

          4. Steven Kopits

            I find two different measures of German unemployment. Which should we use?

            Per OECD data, 3.1%:
            Per the German Federal Labor Agency, 4.9%:

            Germany’s unemployment rate slid to 4.9% in September, helped by a traditional uppick in hiring after the summer vacation.

            The Federal Labor Agency said Monday that the unadjusted jobless rate — the headline figure in Germany — declined from 5.1% in August. Some 2.234 million people were registered as unemployed, 85,000 fewer than the previous month and 22,000 fewer than a year earlier.

            In seasonally adjusted terms, the unemployment rate was static at 5% for the fifth consecutive month.

            Germany, Europe’s biggest economy, has seen gloom over its outlook increase over recent months.

    2. Barkley Rosser


      Given its chronic and large trade surplus, Germany does not seem to have a problem with “competitiveness.” I happen to disaprove of them shutting down their nuclear plants as a hysterical reaction to Fukushima, which has placed a serious burden on other European nations. I also agree with Menzie that their infrastructure is not all that great. I have been there recently. For such a high income nation, their infrastructure should be better than it is.

      1. Steven Kopits

        If they need to fix their infrastructure, fix it. Should have to be bundled into a stimulus program. That’s a bad way to do it, all things considered.

        1. pgl

          “If they need to fix their infrastructure, fix it.”

          But you said their infrastructure was great. Oh wait – economists in Germany have noted you are full of $hit. BTW – if one spends a lot on infrastructure that is per se an increase in aggregate demand. OK – one could raise taxes to pay for it but I have never seen you put forth such a coherent proposal on this. Just a lot of your usual stupid harping on how others are allegedly not up to your pathetically low standards.

      2. Ulenspiegel

        “Given its chronic and large trade surplus, Germany does not seem to have a problem with “competitiveness.” I happen to disaprove of them shutting down their nuclear plants as a hysterical reaction to Fukushima, which has placed a serious burden on other European nations.”

        If you are too lazy or stupid to get the basic facts right, nobody assumes you are able to get the fine points: The Atomausstieg was deceided in 2003 by the Schröder government and became law in 2004. Around 2008 the FDP (liberals) tried to reverse this against the will of the majority of Germans and as junior coalition partner in the first Merkel government persuaded Merkel, THIS attempt was killed by Fukushima. Merkel did not act in a hysterical way, that happened only in your head.

        The 2011 Atomausstieg is basically the same as the 2003 and did not hurt German neighbours. A nice side effect is that German companies said good-bye to nuclear power early and became successful in other fields like offshore wind power, the French industries have not develeoped any alternative.

        “For such a high income nation, their infrastructure should be better than it is.”

        That is correct, however, misses the point. Neither you or Frenkel address the issue that German construction industry is booked out and run at 100% (for years), there is simply no spare capacity left that allow a fast increase of economic activity in this field. Actually, federal money is not used by the Länder for this reason.

        Germany needs some programs, however, these will not change the situation fast, Large scale green investments would be a good idea but take time.

        1. Barkley Rosser

          Oh great, not only do we have hysterical German showing up here spouting off a lot of self-righteiousness, but one who is also a stinking hypocrite to boot as well.

          As it is, the nuclear issue is a sideshow to the topic of this post, and I agree with your timeline of when things happened. But the reaction to Fukushima was hysterical, and it did damage Germany’s neighbors, something Germany has been known to do quite a bit of, so nothing new there. The move was hysterical because none of Germany’s nuclear power plants are situated like those at Fukushima. None have been in any danger of being hit by a tsunami. Just plain hysterical and dumb.

          The hypocrisy come in because the move raised electricity rates all over Europe so that a bunch of hysterical Germans could feel good. But the hypocrisy comes in not just from that, but from the fact that Germany increased its use of awful coal and increased CO2 eimssions. Do you want too justify that disgusting garbage, Ulenspiegel.

          And you have the audacity to criticiize France? Even worse hypocrisy. In 2017 per capita CO2 emissions in France were 5.4 tons per year while in Germany they were 9.2 (although over 15 in US). Really, Ulenspiegal. You are a hysterical hypcritie. Just disgusting.

    3. pgl

      “You really should read some actual academic work before spouting off.”

      Ouch! Now as far as Stevie’s “Why? Is infrastructure in Germany in bad shape? It wasn’t when I was there last.”

      Maybe our self styled know it all should check this out:

      “This week, a runway at Hanover airport cracked because of unusually hot temperatures while some German roads have also buckled this summer. In an age of rising temperatures, can the country’s concrete hold up? … No investment please, we’re German Germany has a long-established infrastructure investment problem. Since a post-reunification investment boom in the early 1990s, the net infrastructural investment of German states has plummeted, with the belt-tightening generally blamed on “debt brakes” imposed on state and federal spending by the German government during a financial crisis in 2001 and during the global financial crisis almost a decade ago. With less money available for capital projects across the country, important investment has often been delayed. Stories of crumbling infrastructure — from road, to rail to public buildings — have been quite common in Germany in recent years.”

    4. pgl

      “Has Germany been skimping on maintenance? ” Yes it has Stevie boy. Check out the link I provided and the many links it provides. As usual your stupidity dwarfs even your overbloated arrogance!

  5. pgl

    Jeff Frankel suggested German needs more infrastructure investment. Of course Princeton Stevie boy in all of his arrogance laced with sheer stupidity attacked Jeff for making this comment. OK, maybe we need some neutral and informed person to settle this:

    ‘An expert commission has said investing more public money in infrastructure improvements would lead to a stronger German economy — and the government isn’t short of money. So what’s holding up needed investments? For years, German economists have warned that the level of public and private investment in the country’s public and private capital stock was dangerously low. Hard infrastructure such as roads, bridges, and broadband fiber optic networks have been getting insufficient funding. Many school and pre-school buildings also need updating, according to senior economists at leading think-tanks like the German Institute for Economic Research (DIW), German Institute for Urbanism (DIFU), or Bertelsmann Foundation.’

    Huh? I wonder if the self styled expert who claims he’s from the city of Princeton (no one at the economics department of Princeton University seems to know this know-it-all) has better research than these German economists?

  6. Steven Kopits

    Tell me, Menzie, what is the right interest rate with a declining population? If the demand for real estate is falling — and it should — shouldn’t there be natural deflationary pressures in the economy? Wouldn’t this pair with very low interest rates? Is that a good thing, or to be avoided? Should monetary policy, a la Scott Sumner, target NGDP growth of x (say, 4%) and employ MMT is that’s necessary to get inflation high enough to reach NGDP targets given that QE does not appear to be particularly effective? Or is it ok for the ten year rate to go negative? What, in your opinion, is the correct policy?

    1. pgl

      All questions but no answers from the peanut gallery. I guess your Princeton “policy” analysis is limited to whiny harping.

  7. pgl

    I hope this is not WAY over Princeton Steve’s head but I thought the Meade-Swann diagram applied to Germany might be helpful:

    ‘On the vertical axis we have a measure of the real exchange rate, here defined as the ratio of the nominal exchange rate to the wage. In the case of Spain, being in the euro, there´s no way it can independently change the nominal exchange rate. The real exchange rate indicator used can be interpreted as a measure of the Spain´s “competitiveness” relative to, say, Germany. The horizontal axis measures aggregate demand (absorption). The Internal Balance (IB) line represents points such that the combination of the real exchange rate and absorption are consistent with a measure of IB, here defined as unemployment at the “natural” rate. The External Balance (EB) line represents points such that the combination of real exchange rate and absorption are consistent with a measure of EB, here defined as a “balanced” current account (CA). The figure is divided in four quadrants. Quadrant I depicts a situation where the country is running a current account deficit (D) and unemployment is above the “natural” rate (U). Quadrant III represents a situation of CA surplus (S) and “overheated” economy (O), one in which unemployment is below the “natural” rate, and so forth for the other quadrants. Spain is clearly deep inside quadrant I, running a CA deficit and with high unemployment. Let´s put Germany in quadrant III, running a CA surplus and with unemployment close to the “natural” rate. The charts illustrate the CA and unemployment situation in both Germany and Spain.’

    The point of this particular blog post was to demonstrate the dilemma Spain is in given that it has tied its currency to the Euro, which is the currency of Germany. The blog post continues:

    ‘Germany (as representative of the “core”) could give a helping hand by taking steps to reverse the policies that led to the crisis. They can cut taxes in order to reduce domestic savings and increase domestic consumption. These measures would amount to an interval appreciation, raising wages and prices relative to Spain, thereby increasing Spain´s competitiveness and reducing its CA deficit for any given amount of “austerity”. But Ms Merkel is the “nein, nein, nein” lady and people like Bundesbank President Jens Weideman would go crazy with the idea. To them what´s needed is more “austerity”!’

    OK – we need to explain to dunderheads like Princeton Steve that infrastructure investment – like tax cuts – are another form of fiscal stimulus. Now this blog post assumes Germany was already at full employment but what if its own aggregate demand slipped below full employment, which is what Jeff Frankel was noting. Then the case for German fiscal stimulus is even stronger. This should be obvious to anyone who actually gets international macroeconomics, but it has become clear that Princeton Steve has no clue about topics like these.

        1. pgl

          I see. 2slug draws in the sand box for little Stevie boy can understand. Yep – you are both pompous and stupid by choice. You know Stevie – there is a lot of excellent economics out there that you choose to ignore. Which is why the rest of us should just ignore your incessant gibberish.

  8. pgl

    “Steven Kopits
    October 7, 2019 at 8:57 am
    I find two different measures of German unemployment. Which should we use?”

    This should make us all laugh out loud. Steven Know it All Kopits does not realize that there are different ways to report labor market statistics such as the unemployment rate? He does not know that the OECD puts forth a standardized definition when doing cross country comparisons?

    Look maybe others did not know this either but I would have thought it was common knowledge. Of course I would not bash people who come here for an honest exchange of ideas. But Princeton Stevie THINKS he knows more than people like Jeffrey Frankel. You see Princeton Stevie is a pompous blow hard who deems to lecture the rest of us on topics he does not understand it all.


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