May 16, 2003

The New German Recession

The Economist reports that the German economy has gone into the tank:

Economist.com: ...Today it is Germany that economists point to with a mixture of contempt and alarm--emotions reinforced by confirmation on May 15th that the economy is technically in recession, with two successive quarterly declines in output.

The latest figures were even worse than anticipated, with GDP falling by 0.2% in the first quarter of this year compared with the last three months of 2002. Every new number seems to bring more bad news. The unemployment data have for months been causing the German chancellor, Gerhard Schroeder, particular embarrassment. The jobless total is now higher than when he first took office in 1998, in spite of his pledge during that year's election that he would cut unemployment. Industrial production is falling, as are manufacturing orders, hit by a combination of weak domestic demand and falling exports, squeezed by the sharp rise in the euro.

The decline of Europe's largest economy has worrying implications not just for its immediate neighbours but for the world economy as a whole. The government's weak and flustered response is equally troubling. Instead of using his strong mandate in 1998 to push through much-needed reforms of the German labour market and social welfare system, Mr Schroeder shied away from confrontation with the powerful German unions, the traditional supporters of his governing Social Democratic Party. Only now is the chancellor struggling to ram through some of the changes needed if Germany is to have any hope of revival in the longer term. He faces considerable opposition from the unions and other left-wing groups that want to preserve Germany's very generous system of pensions and benefits.

The country?s problems are so acute that the reform programme will not, by itself, be enough to halt the economy?s accelerating fall. The government?s room for short-term manoeuvre is limited, though, by its membership of the euro area. Monetary policy is no longer in German hands and the European Central Bank (ECB) has shown a remarkable reluctance to cut interest rates, despite having room to do so. Real interest rates are now significantly higher in the euro area than in America--which might partly explain the sharp appreciation of the euro against the dollar recently.

Unfortunately, the scope for relaxation of a fiscal kind is also heavily constrained--by the stability and growth pact which sets limits on government borrowing. Germany, along with France, Portugal and probably Italy, is already in breach of the limit--currently 3% of GDP. The European Union has already modified the rules once, by delaying the deadline for balanced budgets from next year to 2006. But Mr Schroeder and his colleagues have recently admitted that even this new deadline will be missed. This is all very embarrassing, as Germany was the principal architect of the pact in the first place. It is also damaging, since the government is not free to pursue the sort of fiscal loosening that might really make a difference.

On top of all this comes the problem of deflation...

Posted by DeLong at May 16, 2003 09:54 AM | TrackBack

Comments

If there ever was a time for easy money, this is it. What's the matter with this ECB? Afraid of inflation? Incidentally, the weak U.S. dollar is being properly praised from an American perspective by Lawrence Kudlow in today's NRO as far as increasing U.S. net export demand (his term nincompoop still applies to LK but even a nincompoop gets lucky) but then that means less net exports for Europe.

Posted by: Hal McClure on May 16, 2003 10:21 AM

I'm a noneconomist, math oriented person. Technical explanations aren't beyond me, but understanding the likely interactions between large economies is. So I was hoping that some of the more economically gifted types here might explain the likely effect Germany's "going under" will have for us here. Effects on deflation, imports, exports...?

Posted by: Barnacle Bob on May 16, 2003 11:17 AM

Barnacle

Read Stephen Roach -

http://www.morganstanley.com/GEFdata/digests/latest-digest.html

The French have taken to the streets in protest of pension reforms. The politics of labor market reform are meeting great resistance in Germany. The Japanese have intervened in foreign exchange markets in an effort to stem the appreciation of the yen. And Washington seems to be doing everything in its power in order to boost a sluggish US economy. These actions all have one thing in common -- they reflect efforts to resist the increasingly powerful forces of global rebalancing. In the end, I think any such resistance is doomed to failure....

Posted by: anne on May 16, 2003 01:08 PM

Germany's slow growth won't have too much impact on the US, because America's external sector is relatively small. People in third countries are likely to divert their exporting drives to the American market, and the Germans will buy fewer American imports. And the Germans will buy fewer American exports. America's trade balance will move further into the red, but the impact will be relatively limited.

There are two caveats to that: if the German banking system starts to implode, and the ECB messes up (don't forget that the ECB has yet had to be the lender of last resort), that could pose a systemic risk to the integrated world financial markets, including America's; or if America's deficit finally becomes too large to be financed, then American interest rates could soar and the economy could experience a severe recession. But this won't be the straw that breaks the camel's back.

Posted by: PJ on May 16, 2003 01:10 PM

Hal - well easy money hasn't done so good for Japan, and it isn't doing so good in America either. America's last general quarterly GDP increase was around 1.5%, which is around the increase in America's population : in other words, what makes the U.S. economy grow at the moment is the population is growing. Germany, with a stable population, is doing as well with 0% increase in GDP.

So maybe a little modesty from the economists is in order. Western economies haven't experienced basically stable or falling prices since - well since I don't know when - and so all those economic theories about what to do, have just not been tested by the harsh winds of reality. It's like a scientist making a prediction about ice based on the theories he's developed by carefully observing water.

So, given the fact that lowering interest rates hasn't helped so far, maybe the conclusion which should be drawn is not that we should lower them some more, but that it's not going to help even if we do lower them more. In brief, a certain amount of skepticism is in order towards this panacea.

Posted by: Andrew Boucher on May 16, 2003 01:11 PM

Hal - well easy money hasn't done so good for Japan, and it isn't doing so good in America either. America's last general quarterly GDP increase was around 1.5%, which is around the increase in America's population : in other words, what makes the U.S. economy grow at the moment is the population is growing. Germany, with a stable population, is doing as well with 0% increase in GDP.

So maybe a little modesty from the economists is in order. Western economies haven't experienced basically stable or falling prices since - well since I don't know when - and so all those economic theories about what to do, have just not been tested by the harsh winds of reality. It's like a scientist making a prediction about ice based on the theories he's developed by carefully observing water.

So, given the fact that lowering interest rates hasn't helped so far, maybe the conclusion which should be drawn is not that we should lower them some more, but that it's not going to help even if we do lower them more. In brief, a certain amount of skepticism is in order towards this panacea.

Posted by: Andrew Boucher on May 16, 2003 01:16 PM

Hal

I have serious serious doubts as to whether we can spur growth with a weak dollar. We are not likely to grow faster at the expense of Japan or Europe. I would have wished for more direct government spending, say revenue sharing with the states and the like, to spur growth.

Posted by: anne on May 16, 2003 01:20 PM

Andrew, the economists are way ahead of you. They scream how Germany has to take neo-lib style medicine: "push through much-needed reforms of the German labour market and social welfare system" but, here's the kicker:

"The country's problems are so acute that the reform programme will not, by itself, be enough to halt the economy's accelerating fall."

So do what we say but it's not our fault when it fails yet again. Argentina rolls its collective eyes.

Well, that's unbridled arrogance for you. Somebody needs to do a chart of growth/GDP, as somebody smartly alluded to above. In fact, since growth as measured by today's mainstream economists is pretty much simply consumption, we should maybe do growth/body mass. Bet America wouldn't look so good.

Posted by: a different chris on May 16, 2003 01:28 PM

Andrew

You seem to be suggesting Europe is in a liquidity trap as well and maybe you're right. But then should the EU relax its restrictions on deficits so they can run fiscal stimulus. It's sort of like Herbert Hoover is now running Europe.

Posted by: Hal McClure on May 16, 2003 01:51 PM

"If there ever was a time for easy money, this is it. What's the matter with this ECB?"

I see two things wrong with the ECB:

1) As I understand it, their mandate has no economic growth component. They are charged with controlling inflation, period. This is as opposed to the U.S. Fed, which I understand to have both an inflation and growth mandate.

2) It seems to me that there is an inherent problem of being a central bank for a large number of countries. I think this is especially true when the countries are at various wealth levels and stages of development.

No, three things wrong with the ECB:

3) Their union-wide inflation target is too low, and, like the Bank of Japan, the ECB seems to be incapable of adjusting mentality to meet this reality.

No, four things wrong with the ECB:

4) ruthless efficiency, and an almost fanatical devotion to the Pope. ;-)

Posted by: Mark Bahner on May 16, 2003 03:06 PM
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