SPAIN, Italy and Greece are taking a knife to public spending because they have no choice. But Germany is still healthy enough that it could do its troubled trading partners a favour and focus more on promoting demand and less on cutting debt.
Could, but almost certainly will not. Even if German politicians had not made a balanced budget a constitutional obligation two years ago, there is a deep consensus among policymakers and economists that austerity and growth are not enemies: they are comrades.
Jens Weidmann, president of the Bundesbank, the German central bank, was channelling generations of hawkish predecessors last week when he called on the government of Chancellor Angela Merkel to speed up efforts to cut new borrowing close to zero.
"We must quickly achieve a structurally balanced budget," Dr Weidmann said in an interview with the Tagesspiegel newspaper. Germany should set an example for the rest of the beleaguered euro zone, he said.
The Bundesbank president speaks for a large swath of the German public, and his comments suggest that President Nicolas Sarkozy of France and Prime Minister Mario Monti of Italy should not expect more of a financial commitment when they meet Dr Merkel in Berlin this week. "One of the lessons of the crisis," Dr Weidmann said, is that cutting budget deficits "should be postponed as little as possible".
That view annoys many people outside Germany who see it as another example of the country's lecturing to the rest of Europe while putting a priority on its domestic interests. Germany, with the lowest borrowing costs and strongest economy, should lend the rest of Europe a hand, they say.
"Germany is the only country that has this freedom, and if they don't use this freedom, that is bad," said Eric Chaney, chief economist at AXA Group, a French insurer.
With interest rates on German bonds close to zero, Mr Chaney noted, shouldn't the country be using this cheap money to invest in education and infrastructure and stimulating demand around Europe?
"If Germany has a problem, it is the instability of the euro," he said.
Evidence of a coming downturn in the euro zone remains strong. Retail sales in the euro area fell nearly 1 per cent in November from October, according to data released on Friday, while unemployment remained at 10.3 per cent. The European Commission's confidence indicator fell last month for a 10th month in a row.
Despite the worsening circumstances, German fiscal policy is already set in stone. In 2009, the country adopted a constitutional "debt brake" that requires a nearly balanced national budget by 2016. Berlin can achieve that requirement only if it starts reducing deficit spending now.
One problem is that the benefits of government spending depend on whether politicians spend the money wisely. Better schools may promote long-term economic growth. Chauffeured limousines for members of the Italian parliament do not.
"Governments spend too much in good times, and they spend even more in bad times," said Dennis Snower, president of the Kiel Institute for the World Economy in Germany. "To have some constraints is a good idea."
Professor Snower believes the German debt brake is overly rigid, but that all euro-zone countries should have built-in limitations on spending. If Greece had such a law, he argued, it would improve investor confidence and perhaps even allow the country to avoid cutting social services in the middle of a brutal downturn.
Germany accounts for little more than a quarter of euro-zone output. While that is a lot, Professor Snower argued that it would be illusory to think that Germany could stimulate its economy enough to rescue Europe.
"You don't need Germany to do foolish things to help Europe because these countries can do things themselves," he said.
Frequently Asked Questions about this Article…
What is Germany's 'debt brake' and how does it affect public spending?
The 'debt brake' is a constitutional rule Germany adopted in 2009 that requires the national budget to be nearly balanced by 2016. It forces the government to reduce deficit spending now, which constrains how much Germany can increase public outlays even if other euro‑zone countries want it to stimulate demand.
Why is Germany unlikely to boost spending to help the rest of the euro zone?
Germany faces both a legal obligation from the debt brake and a broad political and economic consensus that austerity and growth can go together. Bundesbank officials and many policymakers favour rapid deficit reduction, so Berlin is unlikely to take big new spending steps to prop up partners such as Italy, Spain or Greece.
What did Bundesbank president Jens Weidmann say about German fiscal policy?
Jens Weidmann urged the government to 'quickly achieve a structurally balanced budget' and to cut new borrowing close to zero. He argued Germany should set an example for the euro zone and minimise the postponement of deficit reduction.
With German bond yields near zero, shouldn't Germany borrow to invest in infrastructure and education?
Some economists, including AXA's chief economist cited in the article, argue that low German borrowing costs are an opportunity to invest in education, infrastructure and to stimulate demand. But political realities and the debt brake make such borrowing unlikely, and German policymakers generally prioritise fiscal restraint.
What economic signs point to a possible euro‑zone downturn investors should watch?
Recent data in the article point to weakening demand: euro‑area retail sales fell nearly 1% in November versus October, unemployment remained high at 10.3%, and the European Commission's confidence indicator fell for a tenth straight month. These are warning signs investors often monitor for recession risk.
How could Germany's fiscal stance affect investors in Spain, Italy and Greece?
If Germany sticks to austerity rather than boosting demand, struggling euro‑zone economies may continue cutting public spending to meet their own constraints. That can prolong weak domestic demand, potentially weighing on corporate profits, sovereign risk perceptions and investment returns in those countries.
Does the type of government spending matter for economic recovery?
Yes. The article highlights that spending quality matters: productive investments like better schools can support long‑term growth, while wasteful spending (the article gives the example of chauffeured limousines) does not. Smart, well‑targeted public investment is more likely to help recovery than indiscriminate spending.
What practical steps can everyday investors take given Germany's likely fiscal restraint?
Investors should monitor euro‑zone economic indicators (retail sales, unemployment, confidence measures) and political developments around German fiscal policy. Expect that slow growth in Europe could affect corporate earnings and markets; staying diversified and focusing on fundamentals and risk management is sensible given the uncertainty described in the article.
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