Dr. Ludger Schuknecht, Chief Economist at the German Finance Ministry
Macroeconomic stimulus is a hard habit to kick, so many economists keep asking for more.
They point to the stock market turmoil in China, the recession in Brazil and the oil price decline. And they have influential friends. Many expect the International Monetary Fund to use its meeting this weekend to call on Germany to provide more fiscal stimulus. The fund will probably tell countries to go easy on fiscal consolidation, too. The US Federal Reserve has been applauded by economists for delaying its rate rise.
Yet, after decades of attempts to fine-tune the economic cycle by running fiscal deficits and cutting interest rates at times of weak demand, many economies are fragile. In too many countries debt and public spending are high, and interest rates close to zero. This leaves little room for effective policy when the next crisis hits – as it surely will.
Government deficits and private-sector debt are at high levels in emerging markets, and many western ones too. Ageing populations are weighing on public finances. Military conflicts and failed states have led large numbers of refugees to the gates of Europe. Traders gamble on continued bailouts. Ebola has reminded us of the devastating economic damage that pandemics can inflict. Those are just the challenges we know about. And, as we learnt in the weeks after Lehman Brothers collapsed, lots of bad news can arrive at once.
For all these reasons, it is vital we build resilience into the system. There is another reason why this is important. Consumers and businesses are more confident in their economic prospects when they believe governments and central banks can respond to challenges. And confidence is the basis for long-term investment, robust consumption, employment and growth. This may explain why investment has been slow to recover despite extraordinarily accommodative monetary policy.
Yet this lesson goes largely unheeded; policymakers are urged to pile more debt on the existing mountain. Never mind that the effect on growth is becoming smaller and smaller. Never mind that zombie banks and enterprises – which would go under if interest rates were higher – barely invest, which undermines long-term growth prospects.
The work of repairing public sector balance sheets has ground to a halt almost everywhere. What governments save, because debt service costs are low, they often spend. Public debt in many countries is now well above 100 per cent of gross domestic product. This would have been unthinkable a decade ago.
The myopia in macroeconomic policy contrasts with much more convincing global action to repair the banking sector. Here, rebuilding resilience has been the motive for regulatory reforms and capital accumulation in recent years. Banks seem much more robust than they were before Lehman.
Such an approach is also needed for public finances. Nations such as Germany have a strategy geared towards resilience, but face criticism for it. Many economists see balanced budgets as an unnecessary obstacle to expansionary fiscal policy. They gloss over the fact that German debt is only gradually falling to pre-crisis levels. They rarely acknowledge that sound fiscal positions have allowed the country to raise investment and deal with the costs of hundreds of thousands of refugees this year, so far without too much excitement about the costs. Resilience, not profligacy, is the foundation of confidence.
Germany’s sound public finances are also the basis for European stability. Without guarantees and support from Berlin, the €500bn European Stability Mechanism, meant to protect against future crises, would not be credible. Were it not for the strength of Germany’s economy and balance sheet, the European Central Bank would have much less scope to use unconventional policies and remain credible. Not to mention the fact that Berlin is one of the largest contributors to the EU’s €150bn annual budget, a significant part of which is transferred to the poorer countries of Europe and beyond.
In the increasingly globalised economy, nations lacking resilience increasingly rely on support from others who fear that, unless they commit their own resources to fighting faraway crises, they will find themselves engulfed by the gathering storm. This creates a new form of moral hazard: since countries that behave recklessly will be bailed out, they have little incentive to reform.
The Group of 20 leading nations and the IMF should aim to make the international financial system strong by improving the resilience of their members. Unless they do, talk of global safety nets is futile, and focusing instead on stimulus is outright frivolous.
This article first appeared in the Financial Times on 6 October 2015.