“Where is Angela?” is the question The Economist asked when French President Nicolas Sarkozy, British Prime Minister Gordon Brown and European Commission President Jose Manuel Barroso met to prepare a European economic stimulus plan without German Chancellor Merkel present. Indeed, Germany is currently the spoiler in the competition to provide billions to prevent a breakdown of the world economy. Why is Germany so hesitant when it comes to economic stimulus programs?
One popular theory is that, given the supply-side orientation of German economists, there is little sympathy for Keynesian, demand-oriented prescriptions. But no German economist has come out against an economic stimulus program, and many favor one. Whereas Keynesian theory has largely disappeared from economic textbooks in the US, it continues to be taught everywhere in Germany. German economists, in contrast to their American colleagues, never abandoned Keynesian policies as a means to combat demand deficits. Moreover, German politicians rarely heed the advice of German economists.
A second hypothesis is closer to the truth: The decline of economic activity in Germany thus far has not been as strong as in other countries. Germany did not have a real-estate bubble that threatened to burst, as did Britain, Ireland, Spain and France. Germany has only been indirectly affected — by the decline in worldwide demand for German products — which explains an important timing difference in the business cycle.
Whereas unemployment in the US has been rising for one-and-a-half years, Germany is enjoying its lowest unemployment rate in 16 years. The German construction industry and retailing are still stable, as the latest survey of the Ifo Institute shows, and the whole world is profiting from this stability as Germany is the second largest importer of goods and services after the US. While US imports are declining sharply, German imports are holding up — without any economic stimulus plan. This is why many Germans wonder whether the foreign criticism is fair.
To be sure, the world recession will hit Germany with full force. The Ifo Institute has forecast that GDP will contract by 2.2 percent this year. But the contraction will be primarily because of declining exports, a large portion of which consists of investment goods, as well as the drop in domestic equipment investment.
These are areas where there is not much that the state can do to help. It can cut taxes to stimulate consumption and it can invest in construction, but these sectors currently need little help, except perhaps for the automobile industry. This could, of course, quickly change. When the second-round effects hit the domestic sector in the course of this year, a stimulus program will be needed. From the German perspective, the best timing for such a program would be in autumn. If the money is spent now, the economy in some sectors could overheat, helping no one.
Paul Krugman, who has aimed massive criticism at Germany’s government, should keep this in mind. Krugman is an excellent economist. He is right in principle in demanding a major economic stimulus package from the German government that goes beyond the 35 billion euro (US$49 billion) already planned. But he should not ignore the time lags between the US and the German economic cycles. Germany should prepare its economic stimulus program now and implement it when the time comes.