Stark vs Horn: Exchange of Ideas on Money in Germany

February 18th, 2015
in Op Ed

by Dirk Ehnts, Econoblog101

Yesterday, both Jurgen Stark of Deutsche Bundesbank and Gustav Horn, who is connected to the unions, voiced their opinion on the euro zone crisis - Stark in the FT (paywall), Horn in Die Zeit (in German).

Follow up:

It was very interesting because apart from the fact that they do not agree they use completely different styles to address the readers. In short, Horn relies on persuasion:

Um eine Erkenntnis kommt man deshalb nicht mehr herum: Das Vorhaben, durch hartes Sparen die Schulden zu reduzieren, war von Anfang an zum Scheitern verurteilt. Denn es beruht auf zwei gravierenden Denkfehlern, die in den vergangenen Jahren immer offenkundiger zu Tage traten. Auf den ersten Blick erscheint die Strategie durchaus plausibel: Wer spart, hat weniger Schulden. Das kann jeder Privathaushalt unmittelbar nachvollziehen. Deshalb wurde ja auch die schwäbische Hausfrau zur Ikone der Sparpolitik erwählt.

He attacks the idea that you reduce a country's debt through thrift (the Swabian housewife). He tries to persuade readers that what is right for a single household is wrong for all households (= the economy). Not everybody can save more, because my expenditures are someone else's income. That someone cannot possibly save more if I reduce his income by spending less (and saving more). Contrast this with Stark's text:

Years of mismanagement and failure to observe the rule of law have led to increasing budget deficits and mounting debts. Risk premiums soared. [..]

Such reforms are painful. But they are necessary in order to return to a solid growth path. [..]

Keynesian thinking has never played such a large role as in Anglo-Saxon countries. German thinking is founded on "ordoliberalism", an approach arising from the recognition that markets need rules to be set and enforced by government.

This is a mixture of misrepresentations and ideology. First of all, Spain and Ireland ran budget surpluses for the years before the crisis, not budget deficits. Here is Ireland's and Spain's government debt year by year from 2003 to 2007 (in 2008 the crisis hit and debt went up):

year - Ireland - Spain - Greece

2003 - 30.1 - 47.6 - NA
2004 - 28.3 - 45.3 - NA
2005 - 26.2- 42.3 - NA
2006 - 23.8 - 38.9 - 103.4
2007 - 24.0 - 35.5 - 103.1

The data for Greece was apparently taken out of the database because at the time Greece played some financial tricks that it learned from Goldman Sachs. Spiegel reported in 2010:

Goldman Sachs helped the Greek government to mask the true extent of its deficit with the help of a derivatives deal that legally circumvented the EU Maastricht deficit rules. At some point the so-called cross currency swaps will mature, and swell the country's already bloated deficit.

Greece was the odd man out anyway, since the other crisis countries - Ireland and Spain - had very low levels of debt that were sinking from 2003 to 2007. At the same time, Germany got letters from Brussels because its deficit was too high!

Stark then mentions reforms that are painful but necessary. I think there is now enough proof to conclude that austerity policies did not help to increase growth. They were started in 2010, and none of the countries has seen a rebound. The euro zone has entered deflation territory and demand remains weak.

Last but not least, the remark about cultural difference and that Keynesianism did not take root in Germany. This again is a remark that is ideological and does not explain anything. Ideas are not German or American or, in the case of Keynesianism, British. If I remember correctly, Keynesian ideas were very popular as late as 2009. Let's have a look at the speech of Jürgen Stark from June 2009, when he was still executive member of the board of the ECB (my highlighting):

Fiscal policy measures

Let me now turn to the fiscal policy reaction to the economic crisis. Fiscal authorities in the euro area have demonstrated their willingness and capacity to act rapidly and in a coordinated manner in exceptional circumstances. It is important to distinguish between measures intended to support the banking sector and fiscal policy measures aimed at stimulating demand. [..]

In addition to providing financial support to the banking sector, euro area governments reacted forcefully to counter the negative impact of the financial turmoil on the real economy. Besides the operation of automatic stabilisers, which provide a significant cushion to the euro area economy by way of lower tax revenues and higher spending on unemployment benefits, the discretionary use of fiscal policy helped to mitigate the effects of the global economic downturn.

So, let me put that into proper context. When Germany in 2009 was on track for -5% GDP growth, discretionary use of fiscal policy helped to mitigate the effects of the downturn. However, in 2010-2015, when there has been no downturn in Germany but still downturn almost everywhere else in the euro zone, than discretionary use of fiscal policy cannot and will not help to mitigiate the effects of the downturn. Quite the opposite: discretionary use of contractionary fiscal policy is supposed to mitigate the effects of the downturn!

Theories are intellectual entities, and have no national bias. Of course that does not mean that the Bundesbank, which mostly follows monetarism (at least the political leadership does), is "neutral" when it comes to theory. But I would argue that this focus on monetarism is not the result of intellectual insight but rather intellectual closure. After all, the monetarists have lost one fight after the other without discarding the idea that the central banks control reserves and banks lend those reserves to the private sector whereas other central bank, like the Bank of England, have discarded these views.

If the FT would be demanding fact checking, then the article by Jürgen Stark would not have gone through. Budget deficits of the crisis countries only went up after the crisis started to hit Europe, not before. Hence there cannot be any causality running from budget deficits to the euro crisis. Also, claiming that reforms that deliver only pain but no increase in welfare should be continued without explaining to the public how they are supposed to work leaves the reader with the impression that the text is an ad hoc justification of bad economic policies.

I think that Horn does the right thing here and discusses the paradox of thrift in order to explain to the public what the problem is. After all, the paradox of thrift is taught to undergrads in macroeconomics courses and the Wikipedia entry is good enough that the lay reader can understand the problem:

The paradox of thrift (or paradox of saving) is a paradox of economics, popularized by John Maynard Keynes, though it had been stated as early as 1714 in The Fable of the Bees,[1] and similar sentiments date to antiquity.[2][3] The paradox states that if everyone tries to save more money during times of economic recession, then aggregate demandwill fall and will in turn lower total savings in the population because of the decrease in consumption and economic growth. The paradox is, narrowly speaking, that total savings may fall even when individuals attempt to increase their savings, and, broadly speaking, that increase in savings may be harmful to an economy.[4]

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