With storm clouds gathering over the economy, what Europe really needs is for Germany to open up its pocketbook and start spending big.
The region is set to receive yet another large dose of monetary stimulus when the European Central Bank meets Thursday. Its outgoing president, Mario Draghi, is expected to sign off with a flourish. But with interest rates already at historic lows, the impact on economic activity is likely to be muted, even if investors rejoice.
Europe’s largest economy is notoriously wary of borrowing. But it’s also on the brink of recession, forcing politicians to consider stimulus options in earnest for the first time since the financial crisis.
The possibility of major German spending to upgrade infrastructure and tackle the climate crisis is generating lots of excitement. Yet experts caution that the country’s lawmakers, determined to maintain a balanced budget, are unlikely to approve the kind of flashy spending package that could give the region a jolt.
“One big bang to support the economy — that is not something the government is willing to do right now,” said Carsten Brzeski, chief German economist at the Dutch bank ING.
End of a golden decade
Germany has been the powerhouse driving Europe’s recovery in the past decade. But recently, its export-driven economy has sagged under the weight of the US-China trade war, flagging global demand for autos and the prospect of a chaotic Brexit.
A recession, which occurs when the economy shrinks for two consecutive quarters, now appears imminent. GDP for the three months ended June contracted 0.1%. The Kiel Institute for the World Economy said Tuesday that it expects German GDP for the third quarter to shrink by 0.3%, and the country’s hyper-cautious central bank has already sounded the alarm.
“Germany’s recession is all but confirmed,” Claus Vistesen, chief eurozone economist at Pantheon Macroeconomics, said in a recent research note, following the release of grim industrial production data.
In this environment, the tenor of conversations about potential stimulus has changed.
“We are in a position to counter an economic crisis with many, many billions of euros if one actually breaks out in Germany and Europe,” Olaf Scholz, Germany’s finance minister, told lawmakers on Tuesday. “And we will do that.”
Driving the conversation, on one hand, is Germany’s hefty budget surplus. Hitting 2.7% of GDP in the first half of 2019, this government surplus gives Germany much more room to maneuver than some of its debt-strapped neighbors.
The other factor is the deeply negative yields on the country’s government bonds. The benchmark 10-year bond currently carries a yield of minus 0.56%, which means that Germany can effectively borrow money for free.
“[Germany] can borrow in the financial market right now at a zero interest rate, and use it for infrastructure investment [and] digital investment,” Brzeski said. “It’s almost a no-brainer.”
The problem, then, is entrenched opposition in Germany to high public spending. This follows the 1970s and 1980s, when unemployment, inflation and government debt all rose, as Deutsche Bank pointed out in a recent note. Then there’s the historical fear of hyperinflation and its destabilizing effects, dating back to the early 1920s.
In modern Germany, there are also reasons that politicians may prioritize a balanced budget over throwing money at a mild recession, said Holger Schmieding, chief economist at Berenberg Bank.
That’s because the effects of a downturn are less painful for many Germans. Companies do everything they can to avoid layoffs because there’s a shortage of skilled labor. Additionally, most Germans rent their homes instead of owning them, so they don’t have to worry about their mortgages.
Above all, there’s widespread reliance on public pensions, which are tied to the health of public finances. That means German citizens want the government to be conservative with its spending.
“Quite a few Germans think if the government spends money now, then it might not have it in 10 years to spend on [their pensions],” Schmieding said. And with the country’s population aging, there are already concerns that spending will become squeezed.
As the clamor for stimulus increases, there’s a growing sense that Germany could be more comfortable about missing its fiscal targets if tax receipts fall during a downturn, according to Schmieding. However, that’s very different from approving a major spending initiative.
Brzeski said he expects crumbs here and there, but nothing that would be a game changer.
The big date to watch is September 20, when Berlin is scheduled to present new climate protection measures. A climate change package could be agreed outside the budget as a “symbolic first step,” Brzeski said.
Beyond that, it’s not clear what Germany can expect. Big spending on infrastructure, for example, may be easier said than done.
“There are severe constraints on how much money you can usefully spend in a country with elaborate planning procedures and a shortage of skilled labor,” Schmieding said.
Stefan Schneider, Deutsche Bank’s chief economist, made a similar point in a recent note, warning that a stimulus package would be “tantamount to a waste of tax money.”
“Germany has enough money to increase government investment, even without taking out new debt,” Schneider wrote. “The real bottlenecks are in the areas of planning and claiming the available funds.”
Some spending in Germany may be on the horizon. But Europe shouldn’t hold its breath.