As the global economy falters, Europe must not leave all the heavy economic lifting to the US and China
- Germany must ditch its fiscal conservatism and put its budget surplus to work
- An ultra-loose monetary policy in conjunction with over-tight fiscal policy is hampering growth and distorting the euro zone yield curve
When a team effort is needed to get a job done, it’s clear if someone is not pulling their weight. In terms of global reflation, Europe is dragging its feet, letting the United States and China do most of the hard work instead.
The EU is ranked the world’s second-largest economy, accounting for 21.4 per cent of global gross domestic product, according to the International Monetary Fund. Europe can afford to do more but seems to be taking out more than it’s prepared to put in.
Germany has plenty of resources to tap into, running a strong budget surplus and an enviable balance of payments, with a current account surplus worth around 7.5 per cent of GDP. Germany should be setting a better lead, using its budget surplus to stimulate domestic demand, boosting imports and helping world trade recover in the process. It’s only German economic conservatism which is standing in the way.
Germany is paying the price for inaction. German business and consumer confidence remain flat, limiting the chances for stronger recovery this year. Unless there is a radical turnaround in the global outlook soon, German growth could go into a dangerous stall.
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It means growing pressure on the European Central Bank to throw caution to the wind and to push for even more negative euro zone interest rates to avoid a deeper downturn. The alternative is to suspend the EU’s Stability and Growth Pact and to ramp up deficit spending in its place.
European growth has been hamstrung by overzealous fiscal consolidation and government debt reduction for far too long. Germany won’t like it but faster fiscal reflation is the best way for Europe to free itself from the doldrums.
Running a super-loose monetary policy in conjunction with over-tight fiscal policy is causing all sorts of problems for Europe’s economy. It’s clearly depressing growth potential but it’s also led to major distortions to the euro zone yield curve, skewing financial market operations in the process. Short-term interest rates need to be negative to make up for insufficient fiscal stimulus.
Meanwhile, excessive safe-haven demand and flight-to-quality factors are pushing long-term European government bond yields further into negative territory. Fiscal consolidation makes the problem even worse as the availability of high-quality, low-risk fixed income assets ends up in relatively short supply. Allowing budget deficits to rise means more bond issuance, rising yields and a return to more normal curves. Germany can hardly disagree with that.
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The answer must be to suspend fiscal stabilisation in Europe and for governments to put more emphasis on investment spending on infrastructure and public works to jump-start recovery. Germany needs to put its budget and trade surpluses to work to promote faster reflation at home and abroad.
Europe is crying out for a fully integrated European fiscal policy which can recycle the surpluses of the wealthier nations into stronger demand in the less well-off economies. A more equitable spread of economic opportunity, wealth creation and prosperity is needed right across Europe, not just for the privileged elite.
There is a lot more that Europe can do to help reboot global recovery efforts in the next few years. Critically, Europe needs to rebalance its policy objectives, switching the focus away from high-risk monetary reflation towards more sustainable fiscal regeneration in the future.
David Brown is chief executive of New View Economics
