Economics and politics - comment and analysis

Deflation is a master from Germany – and the ECB is its victim

These days, we are witnessing a tragedy of historic proportions in Europe. A country called Germany stubbornly and almost unanimously refuses to come to terms with the economic consequences of its own mistakes. It blames all the others but never accepts its own responsibility for what is happening.

In particular, the Christian parties, who persuaded the German people for decades that independence of the central bank is one of the main achievements and pillars of democracy, show with their rabid attacks on the ECB and its current interest rate policy that they know no principles and that laws do not count for them when it comes to their primitive party interests. The intellectual level of these attacks is very low. The lack of intelligence and insight is being outweighed by far by their political brutality, which has recently been increasing on an almost daily basis. The personal attacks are more and more directed towards ECB president, Mario Draghi.

Where does European deflation, which makes up the core of the whole problem comes from? It is mainly because of increasing deflation that the ECB decided to lower the interest rate to zero. Did deflation fall out of the sky? Did the ECB cause it? Are other European countries responsible for it? Such simple questions should be asked in the critical media in Germany every day. Anyone who is intellectually even halfway honest can answer them immediately. Instead, the majority of the German media continue spreading platitudes, giving the impression that there is still some reason behind the madness (Der Spiegel’s long history in this is a sad case in point).

Figure 1


Evolution of price levels in France (green line: labour units costs; black line: the ECB inflation target; red line: prices of goods for exports; blue line: economy in total) (2).

Figures 1 and 2 show the evolution in Germany and in France. They tell you who is responsible for the deflation and the low interest rates. There is no doubt about it that it is Germany. European deflation has its origins in Germany and nowhere else.

Figure 2


Evolution of price levels in Germany (green line: labour units costs; black line: the ECB inflation target; red line: prices of goods for exports; blue line: economy in total) (2).

Both of these figures have been taken from an article which was written by Friederike Spiecker on 1 July last year (see here). The figures make perfectly clear that the source of European deflation is to be found in Germany. This evolution has been ongoing on since the beginning of the European Monetary Union. Clearly, it was the policy of wage moderation, which was implemented by the Red-Green coalition and heavily supported by the CDU/CSU, which made that unit labour costs in Germany did not increase once between 2002 and 2007. This was a clear violation of the rules of the European Monetary Union. The Union had decided in concert to let inflation increase by just below two per cent.

It is also unquestionably correct that the policy which prevailed after the outbreak of the financial crisis and which boiled down to more (and sometimes savage) wage cuts in the crisis countries, which in turn aggravated already existing deflationary trends in Europe, was pushed through by Germany and the Troika in which Germany occupies a dominant position. It is, of course, exactly these policies which led to the monstrous current account imbalances that risk destroying Europe at the end. The fact that a country, which is a member of a monetary union, cannot just export its unemployment to other member states without causing disastrous damages should have been clear to absolutely everyone a long time ago.

The fact that the German current account surpluses result from the wage moderation policy is now even being admitted by Federal Minister for Economy Sigmar Gabriel, who recently wrote that: ‘’Another relevant development in Germany was noticeable wage moderation at the beginning of the millennium. Wage restraint attenuates or reduces labour (unit) costs and thus improves price competitiveness compared to other countries. Direct effects arise, on the one hand, there is an increased demand for exports while, on the other hand, wage moderation weakens incomes and therefore creates a fall in private consumption’ (see here). Is it possible to provide a clearer recognition of the fundamental problem? It is even an adequate depiction of the export of unemployment. That Sigmar Gabriel and his civil servants usually throw everything together and use flimsy arguments, such as high savings rates in Germany to defend the surplus I probably no longer need to mention (we will go into it one more time below) [1].

Those who constantly talk about the role of increasing savings should come to understand that such savings, according to neoclassical theory, which is considered correct by the main political parties (and especially by those in power) as well as by the Bundesbank, provoke specific effects on capital markets. It really does not take much effort to figure this out. What would happen to the interest rate if all economies in the world and all economic sectors were trying to save, in other words what would happen when everybody is offering capital and no one asks for it because none one wants to become a debtor?

In such a completely neoclassical world, the interest rate will fall, what else? On the one hand, this will immediately stimulate deflation, because the interest rate mechanism does not function as the neo-classicists expect (see here) and, at the same time, the neo-classicists will typically try to let interest fall even deeper, just as long until the accumulated savings can be converted into debt (and – perhaps – into investments, that is their theory anyway). In such a world, the central bank can only follow what is taking place in the capital markets. It can never place its own accents.

Figure 3


Financial balances of economic sectors in Germany 1991-2015 (blue line: private households; green line: companies; black line: government; red line: balance with other countries (a negative value shows foreign debt to Germany)) (2).

So, what is going on within the CSU when one of their main politicians (we assume that the transport minister is an expert in these matters and that he carefully reflected on this issue) opines that the ECB policy of holding interest rates low sends a fatal signal: “Social provision and savings make no sense”(see here). He is right: provisions, which are restricted to savings in the traditional sense (we explained this for example here), do not make sense and, paradoxically, his own party president understood this in the meantime (see here).

In the bizarre world of the CDU/CSU, falling interest rates have nothing to do with the ECB. If, as Figure 3 shows, in Germany all sectors are net savers and the whole country preaches to all trading partners that they too should (and must) decrease their debts, then absolutely nothing else can happen than that the interest rate will fall. In the conservative world, which knows no other economic insights than neoclassical theory, interests must logically fall. What happens in Bavaria when more beer is being produced than the Bavarians can consume? The beer price drops!

The ‘attack on the small savers’ of which CSU General Secretary Andreas Scheuer speaks about comes directly from the CSU and the Federal Finance Minister (I really do not want to comment upon the rumour about Draghi and the AfD). The pride with which they celebrate the black zero in the federal budget on the one hand and the brazenness with which they attack the ECB on the other hand is concrete and clear proof that do not understood the crucial relationships or that they just refuse to understand what is really happening. Both possibilities disqualify them from governing one of the major industrial nations of the world. And if it is true that, as Der Spiegel wrote last week, that Sigmar Gabriel and his staff made similar remarks, this applies to them every bit as well.

One is tempted to ignore the absurdity of the attacks and to ridicule the whole thing, but I should be clear about the fact that stupid and/or brazen people are ultimately playing with fire. The tragic combination of German ignorance and economic power revives a lot of old prejudices about Germany. Intelligent German politicians worked for decades to move beyond such preconceptions by cooperating on equal terms with others. However, now the hatred between populations raises its ugly and mighty head again.

[1] The demographic evolution in Germany is among the most ridiculous arguments that are put forward in defense of the German current account surpluses (it is also Sigmar Gabriel’s main argument). I will not go into it again, but Figure 3 clearly shows that the following statement made by the Federal Minister of Economy is wrong. He writes that “One such factor is the demography of a country. The current accounts of a country depend in large measure on age structure of the population. The propensity to save over a life time follows an inverted U-shaped curve: young people who find themselves at the beginning of their careers and older people (especially those who left the labour force) have a lower than average propensity to save. The generation in the middle, on the other hand, has a higher propensity to save (it is located in the ‘accumulation phase’). In addition, expectations regarding the demographic evolution affect both savings and investments and therefore the current account. Societies, such as the German one, in which an increasing part of the population is becoming gradually older see themselves confronted with higher saving rates and with declining rates of investment and this logically translates into lower growth.’’ One can see, however, that the savings rate of private households has not moved at all since the early 2000s. Before that, the savings rate fell more than it rose. It did not increase since the 1960s. That a ‘high savings ratio in combination with low investment’ implies the occurrence of current account surpluses says absolutely nothing, because this is a statement that has no significance for what is being discussed here.

(2) We apologise for using German graphs. The correct Excel file is no longer available.