Wednesday, 22 October 2014

Monetary Policy – Germany to feel the pinch

A taste of its own medicine may prompt Germany to rethink its tough guy approach to Europe

No one like a bully but that seems to be Germany’s role in Europe.  It makes other countries walk the line in policy terms (for their own good) even amid simmering discontent among its neighbours.  Germany has been mean in terms of pushing for monetary policy to be less expansive as elsewhere in spite of struggling countries needing help.  Yet, things may change as the German economy is starting to suffer from similar problems to those it bullies.  Germany is likely to be stuck with monetary policy that is too harsh for even its own economy and this may result in it softening up its approach to others in Europe.

Help wanted

It is a given that the economy in Europe could do with a boost.  Weak demand from consumers and firms means that unemployment remains stubbornly high and inflation for Europe as a whole is not far off zero.  But Germany continues to push its policy of tough love onto Europe.  As with most other developed countries, fiscal stimulus is not an option as governments deal with high levels of public debt.  Germany has gone further in cajoling other governments in Europe to sort out their budget deficits despite the likelihood of adverse economic effects.  

Germany has also not allowed the use of monetary policy as an alternative means of stimulating the economy.  Measures such as quantitative easing have been utilised with some benefits in the US and in Britain but not in Europe even though Europe needs a boost more than anywhere else.  The reasoning behind this approach by Germany is that, by offer laggards in Europe an easy way out, the current problems which are holding them (and Europe as a whole) back will remain in place.  As a result, the European Central Bank has had to be creative and try other measures such as negative interest rates.  But it is difficult for monetary policy to have much effect when its scope is limited.

Turning the tables

Germany may have been able to bully others in Europe but it may be the Germans turn to feel the pain.  The German economy is beginning to flag amid weakening demand for its exports from places such as China.  Forecasts for economic growth in Germany are being cut as its prospects deteriorate while inflation has fallen to below 1%.  The normal response to a weakening economy anywhere else would be for looser monetary policy.  But having not allowed other European countries this option, Germany’s tough stance on others may result it also being tough on itself. 

It is funny to think that the Germans would have likely allowed itself to have more stimulus via monetary policy if there was just a German central bank looking after just the German economy.  But its own actions in influencing monetary policy will mean that Germany may have to endure monetary policy that does not reflect the weak state of its economy (along with most everyone else in Europe).  When framed in this way, Germany must rethink its ideas on economic policy for Europe if just for its own good. 

Continued stubbornness by the Germans would be unconstructive even in comparison to the often dysfunctional politics in Europe.  Deflation is another concern that will only get worse with the current policy measures.  Germany was never going to go easy on others in Europe while its economy was riding high.  It is only a Germany that has been laid low that may soften up and be more willing to help itself by helping others.


  1. The world's economy is slowing. That is a fact.

    The question is, could it keep growing forever? Or is there some point where the GDP per capita simply cannot be increased?

    But I fail to see any progress in economic development that has been achieved through QE. It is a tool developed by central bankers to keep the financial system running.

    That is all.

    Job creation can only come through fiscal policy and the optimism of entrepreneurs.

    I really feel you are barking up the wrong tree if you want the Central Bankers to pull rabbits out of hats and get things running again. Monetary policy across the globe has never been so loose. Zero interest rates and no return on long term bonds, with everybody looking for some means of generating income.

    All we have now are rising asset prices due to far too much cheap liquidity running around, a total focus on short term profit and share price maximisation.

    And still the call is for even looser monetary policies?

    Give me a break, the only voice is coming from the uber wealthy 1%, which is no longer interested in job creation but asset price maximisation.

    And it is here you need to look for solutions.

    1. Thanks for your comments.

      I do understand your lack of enthusiasm for loose monetary policy. It can be seen as an easy way out with limited effect and nasty side effects. I have been critical of measures such as quantitative easing in Japan but still think that monetary policy could have a role to play in reviving the economy in Europe. I think Europe as a while would benefit from Germany softening its stance and allows measures such as quantitative easing as a trade off for reforms in countries such as France and Italy. Reforms would be unpopular but at least there could be seen to be some benefits in the short term.

      Quantitative easing could also be done in other ways such as hands out to tax payers as a way of getting money into the economy faster than going via the financial markets (where it is mostly the rich that benefit which you rightly mentioned above).

      Policy makers in Europe need to be seen to be doing something. In the face of the increasing likelihood of deflation and the rise of populist parties, this seem to me as the best outcome available.

    2. Hi,

      Thanks for replying.

      I have tried and failed to understand what the purpose would be if Draghi starts on an asset purchase binge.

      The chances of France and Italy making any substantial reforms are zero. But maybe France could be the first to reverse out of the Euro. That might be the beginning of a solution.

      Exiting the Euro is the only way for the mess to be fixed. Countries like Greece and France need their own fiscal and monetary policies, which can only happen with their own sovereign currencies.

      The Germans may be comparatively rich, but it is wrong to expect them to dig deep in their pockets to patch over the peripherals. It would only ever be a patch, as the mentality of the Greeks, Italians, Spanish, French, Germans etc is totally different.

      This fundamental will never change.

      And that is why they should not be in this Euro-Construct.

    3. Scepticism may seem like the obvious response to the continuing woes in Europe but I think that the long terms prospects for the Eurozone are not as bad as many people think.

      The weakening economic position of Germany may be what the politicians need to push through the solutions that have been neglected in the few years since the Eurozone crisis. The Eurozone does create benefits such as deeper integration of European markets and Europe needs this more rather than less if current standards of living are to be maintained. It is just a matter of whether the politicians can realise this in time...