By what Policies will Germany overcome the impending Recession?

The recent announcement to shrink 0.1% of the German economy in the second quarter of the year and for the second consecutive quarter has raised concerns with German economic policy planners about what is ahead as much in the immediate as in long-term future, in tackling the recession that strikes the “door” of the German economy.

(Source: Eurostat, https://appsso.eurostat.ec.europa.eu/nui/show.do?dataset=naidq_10_gdp&lang=en 28/08/2019)

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The signs of the impending recession

The international economic environment, through the prices of relevant economic indicators, shows us that the global economy will gradually enter a new recession. The trade and monetary war mainly between the US and China will continue at least until the next elections in the US in November 2020.

The drastic reduction of Germany’s exports to China as a result of the trade wars appears in the monthly results of June (2019M06 (June) index price: 100) and concerns the industrial production of Germany which reached 4.2% lower than in the October 2018 (2018M10 index price: 104,2) six months after the commencing of trade war between USA and China (Source: Eurostat, https://appsso.eurostat.ec. europa.eu/nui/show.do?dataset=sts_inor_m&lang=en, 28/08/2019). This record reduction in Germany’s industrial production is one of the biggest fall of the decade.

Source: Eurostat
https://appsso.eurostat.ec.europa.eu/nui/show.do?dataset=naidq_10_qdp&lang=en, 28/08/2019

Britain’s impending withdrawal from the EU–which without an agreement will additionally hit Germany’s exports to the UK and its industrial production levels-as well as the increased chances of Argentina not being able to repay its agreed obligations.

Also, the crisis in the Persian Gulf between the US and Iran that can become more severe by influencing oil prices that will more heavily burden the anemic growth of the Eurozone.

The ever- “war” President of the ECB Mario Draghi who two months ago he announced that, if necessary, would be implemented a new quantitative easing program, keeping the euro interest rates in a negative sign in order to support both EU and German exports. All these together consist an explosive international economic environment.

But in previous years Germany had been warned by the successive appeals of the IMF to exploit as long as possible its trade surpluses and always in combination with the environment of the almost zero basic borrowing euro interest rate, through the implementation of fiscal policies in the German economy.

Last week, German Finance Minister Olaf Scholz said that Germany could withstand a reduction of €50 billion (or $56 billion) in its treasury, which corresponds to 1,4% of Germany’s GDP (2018 GDP 3,344,370m, Source: Eurostat https://appso.eurostat.eu/nui/show.do?dataset=nama_10_gdp&lang=en 28/08/2019). Statements by German Chancellor Angela Merkel showed that the German government does not consider it necessary to take preventive measures of economic nature at this time.

Olaf Scholz, Erster Burgermeister von Hamburg
Photo by Author: Christoph Braun, Source: Own work, licensed Public Domain
licensed https://creativecommons.org/publicdomain/zero/1.0/deed.en

But this approach to tackling the forthcoming recession is wrong, because both the German financial environment and the ECB’s monetary policy give it great advantages to gently overtake the recession. These advantages can be summarized in the following:

  1. The German government is not burdened with a huge-dimensional debt like the Southern Eurozone member countries.
  2. Inflation is moving at very low levels.
  3. The short-term interest rates for the euro are moving in a negative sign.
  4. The debt of the Federal government of Germany moves to 60% of GDP within the limits laid down in the Maastricht Treaty.
  5. Crowding out investment is not an anxiety.

The only obstacle that appears for the German government is the Constitutionally enshrined term, enshrined in the Constitution of Germany and concerns the “zero debt” or “debt brake” term, which is the crown of economic and political success of the governments of Chancellor Angela Merkel.

This success is based on the German governments managed for years to increase spending on the annual Federal state budget without the use of additional borrowing, continuously achieving surplus Federal state budgets.

These admirably economic achievements have, however, become an act in a prolonged strong development period, which have had low levels of euro interest rates.

Perhaps it is all these economic achievements of the governments of Angela Merkel who are making it reluctant to change this successful economic profile of her governments, with the abolition of this constitutional term on zero debt, preferring to accept a reduction in the state’s reserves by €50 billion, rather than implement a fiscal expanding policy to avoid the consequences of recession. 

Policies to be implemented to address the upcoming recession in Germany

The economic staff of the German government has at the disposal of the unprecedented size of fiscal policy margins. More specifically:

Since the basic borrowing euro interest rate is moving in a negative sign, the German government has the opportunity now to borrow in the long term and to emerge from the repayment plan of this borrowing. The funds to be borrowed should be used to strengthen the weak demand presented in the German economy.

Strengthening the demand side can be done by implementing an aggressive type of fiscal policy that will cause a strong positive shock on the demand side by channeling in the economy a capital size of at least €80 billion which capital can come from either entirely governmental borrowing or a combination of the German government’s own funds and borrowing.

These funds should mainly be directed in reconstruction, maintenance and new construction projects for the modernization of the road and rail network, as well as in the research and development of innovative technologies (e.g. artificial intelligence, robotics, etc.) and in the telecommunications sector (e.g. R&D for development of 5G, 6G networks). However, the German government should:

Quantitatively measure the performance of these projects in the GDP. Then, to estimate the performance that will appear with the quality of these projects (low maintenance costs, ease of replacement and maintenance, low energy footprint, increased competition etc.).

In addition, it should be estimated the quantitative and qualitative performance resulting from the increase in production in the German economy through the implementation of these projects (low cost-high quality of produced products in industry, processing, etc.). They should be measured using quality factors measurement of quality performance (qualitative factors).

The second element to be considered by the German government is the categorization of short-term benefits achieved by the implementation of projects, e.g. the range creation of new jobs for the implementation of these projects, the increase of the GDP etc. Long-term benefits are the degree of deepening of the free market and the facilitation of trade, etc.

The third element that should characterize the funds used for public expenditure in order to implement public works is the degree of influence that they inflict on both the money supply and the change in taxation in the economy that implemented.

But all this takes time, and in the case of Germany, time is money, because there is no time.

At the same time, the German government should reduce the tax burden on both payroll cost and institutionalize zero corporate tax levels for a seven-year horizon if businesses they have proven to reinvest all their profits. 

The results of this aggressive fiscal policy

1. Curbing unemployment at low levels (unemployment 3.1% today).

2. Drastic improvement and renewal of the country’s basic infrastructure, increasing the efficiency of businesses.

3. Increase inflation but always within the limits (< 2%) of the Maastricht Treaty.

(a) improving the competitiveness of the rest of the Euro-area member countries and the EU in relation to Germany.

(b) Help the ECB to achieve artificial inflationary pressures to assist growth in the Euro area by increasing the interest rates in the positive sign. An increase in interest rates will lead to an increase in household savings while all kinds of risk-averse investors (pension funds, insurance companies etc.) will have positive returns from government bonds that withhold as investments. Negative euro interest rates will force savers to gradually withdraw their savings from banks.

4. The size of the funds to be borrowed by the German government will not affect the long-term target of 60% (Debt/GDP ratio) that Germany has achieved to date.

However, it needs courage, adaptability and determination for this policy, given that if nothing is done over time, the consequences of the German economy will become ever greater.

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