Economist : "Double-dip in Germany?"

Artikel aus dem Economist vom 22.08.02

The ECB's monetary policy is much too tight for Germany

WHY are the euro-area economies so weak, and Germany's in particular? Before the euro was launched, German policymakers fretted that the European Central Bank (ECB), influenced by countries with high jobless rates, such as France and Italy, would pursue a laxer monetary policy than would the old Bundesbank, and so hold interest rates too low. The opposite has happened. Interest rates are currently higher than if monetary policy had been set according to conditions in Germany alone. As a result, Germany's economy has been squeezed.

Germany's GDP grew at an annual rate of only 1.1% in the second quarter of this year, leaving it just 0.1% higher than a year ago. Italy's economy also grew by a paltry 0.9% in the second quarter, but the other two big economies, France and Spain, are expected to show stronger growth. Even so, a recent slide in business confidence has caused many economists to trim their forecast for growth in the euro area in 2002, to around 1%. Germany will be lucky to achieve half that. By contrast, the United States is still tipped to grow by over 2%.

So why does the ECB not cut its interest rate, currently at 3.25%, compared with America's rate of 1.75%? The ECB still frets about inflation. The headline rate for the whole euro area, at 1.9%, is a whisker below the 2% ceiling of the ECB's target, but core inflation, excluding food and energy, is 2.5%. Most economists do not expect rates to be cut this year. This raises two questions. First, are rates currently appropriate for the euro area as a whole? Second, how much lower would they be if the Bundesbank was still setting interest rates to suit Germany alone?

Given the ECB's inflation target of "below 2%", which can be interpreted as a range of 0-2%, most economists reckon that interest rates in the euro area are about right. But that target is possibly too low. The closer inflation is to zero, the harder it is to get the negative real interest rates often necessary in a recession, since nominal rates cannot go below zero. Research by the International Monetary Fund suggests that, if average inflation targets are set below 2%, then there is a marked increase in the risk that interest rates will hit zero and that deflation may occur. It might therefore be safer if the ECB aimed for a higher inflation target, with a mid-point (not a ceiling) of 2-2.5%. In which case, interest rates ought now to be lower.

Even assuming that rates are right for the euro area as a whole, policy looks uncomfortably tight for Germany. Its inflation rate is only 1%. And, thanks to weaker growth, the country's output gap (actual GDP less trend GDP) is estimated at minus 3%, twice as large as in the rest of the euro area. A way to gauge the appropriate level of interest rates in Germany is to consult the Taylor rule, devised by John Taylor, currently at America's Treasury Department. This calculates the "correct" interest rate according to the inflation rate and the size of the output gap. It suggests that the German interest rate should now be a full percentage point lower than that set for the euro area as a whole.

In theory, if a country cannot cut interest rates, because of monetary union, it should use fiscal policy to support its economy. Yet Europe's stability and growth pact does not allow euro-area governments to borrow more than 3% of GDP (see article). On current policies, Germany's budget deficit may breach 3% of GDP this year. Under the stability pact's rules, that would force the government to tighten policy, further depressing its economy.

From America with love
A popular excuse for euro-area weakness, including Germany's, is that exporters have been hurt by America's downturn. Yet net exports from the euro area have increased over the past year. It has been weak domestic demand, not external demand, that has dragged down economies. In Germany, exports have been the only source of growth: consumer spending and investment have fallen over the past year.

Even if weak export markets cannot be blamed, the bursting of America's economic bubble has squeezed spending in other ways—through foreign investment, share prices and business confidence. Following a wave of acquisitions in the 1990s, European firms' dollar sales from their American subsidiaries are now four times bigger than their exports to America. America's slump has therefore squeezed parent firms' profits in Europe, forcing them to cut investment back home.

European share prices have also tracked Wall Street more closely than usual—or have fallen further. German equities have fallen by 52% from their peak in 2000. This is more than in other European markets and more than the 40% fall in America's S&P 500 index. Only one-fifth of Germans own shares, compared with half of Americans, so the direct wealth effect is smaller. The indirect effect, through confidence, could be disproportionately large.

In recent years the correlation between indicators of business confidence in America and in the euro area has increased. The mood of European businessmen seems to follow the mood swings of American bosses a few months later. The correlation is closest for Germany (see top chart), where businesses are most exposed to the American market, after buying lots of companies there.

Do European economies have financial imbalances akin to America's? Household saving rates are much higher and the euro area has a current-account surplus, in contrast to America's big deficit. However, Europe is far from being a model of financial prudence. The total debts of non-financial companies in the euro area have climbed, from 47% of GDP in 1997 to 58% at the end of 2001. The debts of American companies also rose sharply, yet are still lower, at under 50% of GDP. Total household debt as a share of GDP is also higher in Germany than in the United States. Slow growth, very low inflation and high debts are a painful combination.

Michael Saunders, an economist at Schroder Salomon Smith Barney, reckons that corporate balance sheets are more fragile than generally assumed, especially in Germany. Corporate bankruptcies in Germany are running at three times their level in the early 1990s; in France they are half their level of a decade ago (see bottom chart).

Many German companies, in other words, look as stretched as do their American counterparts. But, unlike companies in America, German ones have no monetary guardian to rescue them by cutting interest rates. The risk of a double-dip recession, and perhaps even of deflation, might therefore be higher in Germany than it is in the United States.