One of President Trump’s main policy slogans has been ‘America first’. As Trump sees it, a manifestation of a country’s economic strength is its current account balance. He would love the USA to have a current account surplus. As it is, it has the largest current account deficit in the world (in absolute terms) of $481 billion in 2016 or 2.6% of GDP. This compares with the UK’s $115bn or 4.4% of GDP. Germany, by contrast, had a surplus in 2016 of $294bn or 8.5% of GDP.
However, he looks at other countries’ current account surpluses suspiciously – they may be a sign, he suspects, of ‘unfair play’. Germany’s surplus of over $50bn with the USA is particularly in his sights. Back in January, as President-elect, he threatened to put a 35% tariff on imports of German cars.
In practice, Germany is governed by eurozone rules, which prevent it from subsidising exports. And it does not have its own currency to manipulate. What is more, it is relatively open to imports from the USA. The EU imposes an average tariff of just 3% on US imports and importers also have to add VAT (19% in the case of Germany) to make them comparably priced with goods produced within the EU.
So why does Germany have such a large current account surplus? The article below explores the question and dismisses the claim that it’s the result of currency manipulation or discrimination against imports. The article states that the reason for the German surplus is that:
… it saves more than it invests. The correspondence of savings minus investment with exports minus imports is not an economic theory; it’s an accounting identity. Germans collectively spend less than they produce, and the difference necessarily shows up as net exports.
But why do the Germans save so much? The answer given is that, with an aging population, Germans are sensibly saving now to support themselves in old age. If Germany were to reduce its current account surplus, this would entail either the government reducing its budget surplus, or people reducing the amount they save, or some combination of the two. This is because a current account surplus, which consists of exports and other incomes from abroad (X) minus imports and any other income flowing abroad (M), must equal the surplus of saving (S) plus taxation (T) over investment (I) plus government expenditure (G). In terms of withdrawals and injections, given that:
I + G + X = S + T + M
then, rearranging the terms,
X – M = (S + T) – (I + G).
If German people are reluctant to reduce the amount they save, then an alternative is for the German government to reduce taxation or increase government expenditure. In the run-up to the forthcoming election on 24 September, Chancellor Merkel’s centre-right CDU party advocates cutting taxes, while the main opposition party, the SPD, advocates increasing government expenditure, especially on infrastructure. The article considers the arguments for these two approaches.
Article
The German economy is unbalanced – but Trump has the wrong answer The Guardian, Barry Eichengreen (12/5/17)
Data
German economic data (in English) Statistisches Bundesamt (Federal Statistical Office)
World Economic Outlook Databases IMF
Questions
- Why does Germany have such a large current account surplus?
- What are the costs and benefits to Germany of having a large current account surplus?
- What is meant by ‘mercantilism’? Why is its justification fallacious?
- If Germany had its own currency, would it be a good idea for it to let that currency appreciate?
- What are meant by ‘resource crowding out’ and ‘financial crowding out’? Why might the policies of tax cuts advocated by the CDU result in crowding out? What form would it take and why?
- Compare the relative benefits of the policies advocated by the CDU and SPD to reduce Germany’s budget surplus.
- Would other countries, such as the USA, benefit from a reduction in Germany’s current account surplus?
- Is what ways would the USA gain and lose from restricting imports from Germany? Would it be a net gain or loss? Explain.
In a speech in Dublin on 28 January 2015, titled ‘Fortune favours the bold‘, Mark Carney, the Governor of the Bank of England, compared the UK economy to that of the 19-nation eurozone. While he welcomed the ECB’s recently announced quantitative easing programme, he argued that the current construction of the eurozone is unfinished and still has two fundamental weaknesses that have not been addressed.
The first is the fragmented nature of banking:
With limited cross-border banking in the euro area, savings don’t flow to potential investments. Euro-area corporates’ cash balances have risen to the tune of €420 billion, or 3% of GDP, since the crisis, for example. Modest cross-border equity flows mean inadequate risk sharing.
The second is the lack of an integrated fiscal policy.
For complete solutions to both current and potential future problems, the sharing of fiscal risks is required.
It is no coincidence that effective currency unions tend to have centralised fiscal authorities whose spending is a sizeable share of GDP – averaging over a quarter of GDP for advanced countries outside the euro area.
… If the eurozone were a country, fiscal policy would be substantially more supportive. However, it is tighter than in the UK, even though Europe still lacks other effective risk sharing mechanisms
and is relatively inflexible. A more constructive fiscal policy would help recycle surplus private savings and mitigate the tail risk of stagnation. It would also bridge the drag from structural reforms on nominal spending and would be consistent with the longer term direction of travel towards greater integration.
But fiscal integration requires a political will to transfer fiscal surpluses from the stronger countries, such as Germany, to the weaker countries, such as those in southern Europe.
Overall, the financial and fiscal position in the eurozone is strong:
Gross general government debt in the euro area is roughly the same as in the UK and below the average of advanced economies. The weighted average yield on 10-year euro area sovereign debt is around 1%, compared to 1½% in the UK. And yet, the euro area’s fiscal deficit is half that in the UK. Its structural deficit, according to the IMF, is less than one third as large.
But, unlike the UK, where, despite the rhetoric of austerity, automatic fiscal stabilisers have been allowed to work and the government has accepted a much slower than planned reduction in the deficit, in the eurozone fiscal policy remains tight. Yet unemployment, at 11½%, is twice the rate in the UK and economic growth, at around 0.7% is only one-quarter of that in the UK.
Without a eurozone-wide fiscal policy the problem of slow growth is likely to persist for some time. Monetary policy in the form of QE will help and structural reforms will help to stimulate potential output and long-term growth, but these policies could be much more effective if backed up by fiscal policy.
Whether they will be any time soon is a political question.
Speech
Fortune favours the bold Bank of England. Mark Carney (29/1/15)
Articles
Bank of England’s Carney urges Europe to take plunge on fiscal union Reuters, Padraic Halpin (28/1/15)
Bank Of England’s Mark Carney Attacks ‘Timid’ Eurozone Recovery Attempts Huffington Post, Jack Sommers (29/1/15)
BoE’s Mark Carney calls for common eurozone fiscal policies Financial Times, Ferdinando Giugliano (28/1/15)
Carney attacks German austerity BBC News, Robert Peston (28/1/15)
Bank of England governor attacks eurozone austerity The Guardian, Larry Elliott (28/1/15)
Questions
- Compare the financial and fiscal positions of the UK and the eurozone.
- In what way is there a ‘debt trap’ in the eurozone?
- What did Mark Carney mean when he said, ‘Cross-border risk-sharing through the financial system has slid backwards.’?
- What options are there for the eurozone sharing fiscal risks?
- What would a ‘more constructive’ fiscal policy, as advocated by Mark Carney, look like?
- How do the fiscal policies of other currency unions, such as the UK (union of the four nations of the UK) or the USA (union of the 50 states) or Canada (union of the 10 provinces and three territories), differ from that of the eurozone?
The eurozone is made up of 18 countries (19 in January) and, besides sharing a common currency, they also seem to be sharing the trait of weak economic performance. The key macroeconomic variables across the eurozone nations have all seemingly been moving in the wrong direction and this is causing a lot of concern for policy-makers.
Some of the biggest players in the eurozone have seen economic growth on the down-turn, unemployment rising and consumer and business confidence falling once again. Germany’s economic growth has been revised down and in Italy, unemployment rose to a record of 13.2% in September and around 25% of the workforce remains out of work in Spain and Greece. A significant consequence of the sluggish growth across this 18-nation bloc of countries is the growing risk of deflation.
Whilst low and stable inflation is a macroeconomic objective across nations, there is such a thing as inflation that is too low. When inflation approaches 0%, the spectre of deflation looms large (see the blog post Deflation danger). The problem of deflation is that when people expect prices to fall, they stop spending. As such, consumption falls and this puts downward pressure on aggregate demand. After all, if you think prices will be lower next week, then you are likely to wait until next week. This decision by consumers will cause aggregate demand to shift to the left, thus pushing national income down, creating higher unemployment. If this expectation continues, then so will the inward shifts in AD. This is the problem facing the eurozone. In November, the inflation rate fell to 0.3%. One of the key causes is falling energy prices – normally good news, but not if inflation is already too low.
Jonathan Loynes, Chief European Economist at Capital Economics said:
“[the inflation and jobless data] gives the ECB yet another nudge to take urgent further action to revive the recovery and tackle the threat of deflation…We now expect the headline inflation rate to drop below zero at least briefly over the next six months and there is a clear danger of a more prolonged bout of falling prices.”
Some may see the lower prices as a positive change, with less household income being needed to buy the same basket of goods. However, the key question will be whether such low prices are seen as a temporary change or an indication of a longer-term trend. The answer to the question will have a significant effect on business decisions about investment and on the next steps to be taken by the ECB. It also has big consequences for other countries, in particular the UK. The data over the coming months across a range of macroeconomic variables may tell us a lot about what is to come throughout 2015. The following articles consider the eurozone data.
Euro area annual inflation down to 0.3% EuroStat News Release (28/11/14)
Eurozone inflation weakens again, adding pressure on ECB Nasdaq, Brian Blackstone (28/11/14)
Eurozone inflation rate falls in October BBC News (28/11/14)
Eurozone recovery fears weigh on UK plc, says report Financial Times, Alison Smith (30/11/14)
€300bn Jean-Claude Juncker Eurozone kickstarter sounds too good to be true The Guardian, Larry Elliott (26/11/14)
Eurozone area may be in ‘persistent stagnation trap’ says OECD BBC News (25/11/14)
Euro area ‘major risk to world growth’: OECD CNBC, Katy Barnato (25/11/14)
OECD sees gradual world recovery, urges ECB to do more Reuters, Ingrid Melander (25/11/14)
Questions
- What is deflation and why is it such a concern?
- Illustrate the impact of falling consumer demand in an AD/AS diagram.
- What policies are available to the ECB to tackle the problem of deflation? How successful are they likely to be and which factors will determine this?
- To what extent is the economic stagnation in the Eurozone a cause for concern to countries such as the UK and US? Explain your answer.
- How effective would quantitative easing be in combating the problem of deflation?
In the Blog, A VW recession for the eurozone, as German growth revised down?, we discussed the pessimistic outlook for the eurozone, in part driven by the problems facing the engine of Europe: Germany. While the German government noted that the weak growth figures are due to external factors, it appears as though these external factors are now sending waves through the domestic economy.
Over the past 6 months, German confidence has fallen continuously and now stands at almost its lowest level in 2 years. Think tank data from a survey of 7000 firms in Germany fell from 104.7 to 103.2 for October – the weakest reading since December 2012. Confidence is always a key factor in the strength of an economy, as it affects consumers and businesses. 
Without consumer and business confidence, two key components of aggregate demand are weak and this downward pressure on total spending in the economy depresses economic growth. An economist from Ifo, the think-tank that produced this business climate index, said that firms felt ‘downbeat about both their current situation and the future.’
As confidence continues to decline in Germany, the economic situation is unlikely to improve. Unfortunately, it is something of a vicious circle in that without economic growth confidence won’t return and without confidence, economic growth won’t improve. The industrial sector is crucial to Germany and the data is concerning, according to Chief economist at Commerzbank, Joerg Kraemer:
The latest numbers from the industrial sector are very worrisome…The third quarter was probably worse than expected, the economy may have stagnated at best.
Numerous factors continue to depress the German economy and while negative growth is not expected, estimates for quarterly growth from July to September remain at around 0.3%. As Europe’s largest economy, such low growth rates will be of concern to the rest of the Eurozone and may also bring worry to other countries, such as the US and UK. With growing interdependence between nations, the success of countries such as Germany and Europe as a whole influences the economic situation abroad. Commentators will be looking for any signal that Germany is strengthening in the coming months and an improvement in business confidence will be essential for any prolonged recovery.
German business confidence falters again in October Wall Street Journal, Todd Buell (27/10/14)
German business morale weakens to lowest level in almost two years Reuters, Michelle Martin (27/10/14)
Zero growth best hope for Germany as confidence disappears The Telegraph, Szu Ping Chan (27/10/14)
German Ifo business confidence drops for sixth month Bloomberg, Stefan Riecher (27/10/14)
German business confidence plunges again as analysts urge fiscal stimulus International Business Times, Finnbarr Bermingham (27/10/14)
German business confidence falls again, Ifo says BBC News (27/10/14)
German business confidence tumbles The Guardian, Philip Inman (24/9/14)
The German way of stagnating BBC News, Robert Peston (11/11/14)
Questions
- Why is consumer and business confidence such an important element in explaining the state of an economy?
- Use an AD/AS diagram to illustrate the impact on national output of a decline business confidence. What are the other consequences for the macroeconomic objectives?
- What actions can a government take to boost confidence in an economy?
- If economic growth is weak and confidence is low, is there any point in cutting interest rates as a means of stimulating investment?
- If the eurozone did move back into recession, what could be the possible consequences for countries such as the UK and US?
- How useful are indices that measure business confidence?
Europe’s largest economy is Germany and the prospects and growth figures of this country are crucial to the growth of the Eurozone as a whole. The EU is a key trading partner for the UK and hence the growth data of Germany and in turn of the Eurozone is also essential in creating buoyant economic conditions within our borders. The bad news is that the economic growth forecast for Germany has been cut by the German government.
The German government had previously estimated that the growth rate for this year would be 1.8%, but the estimate has now been revised down to 1.2% and next year’s growth rate has also been revised downwards from 2% to 1.3%. Clearly the expectation is that low growth is set to continue.
Whenever there are changes in macroeconomic variables, a key question is always about the cause of such change, for example is inflation caused by demand-pull or cost-push factors. The German government has been quick to state that the lower growth rates are not due to internal factors, but have been affected by external factors, in particular the state of the global economy. As such, there are no plans to make significant changes to domestic policy, as the domestic economy remains in a strong position. The economy Minister said:
“The German economy finds itself in difficult external waters … Domestic economic forces remain intact, with the robust labour market forming the foundation … As soon as the international environment improves, the competitiveness of German companies will bear fruit and the German economy will return to a path of solid growth … [for this reason there is] no reason to abandon or change our economic or fiscal policy.”
The global picture remains relatively weak and while some economies, including the UK, have seen growth pick up and unemployment fall, there are concerns that the economic recovery is beginning to slow. With an increasingly interdependent world, the slowing down of one economy can have a significant impact on the growth rate of others. If country A begins to slow, demand for imports will fall and this means a fall in the demand for exports of country B. For countries that are dependent on exports, such as Germany and China, a fall in the demand for exports can mean a big decline in aggregate demand and in August, Germany saw a 5.8% drop in exports.
Adding to the gloom is data on inflation, suggesting that some other key economies have seen falls in the rate of inflation, including China. The possibility of a triple-dip recession for the Eurozone has now been suggested and with its largest economy beginning to struggle, this suggestion may become more real. The following articles consider the macroeconomic picture.
Articles
Germany cuts growth forecasts amid recession fears, as Ireland unveils budget The Guardian, Graeme Wearden (14/10/14)
As cracks in its economy widen, is Germany’s miracle about to fade? The Observer, Philip Oltermann (19/10/14)
Why the German economy is in a rut The Economist (21/10/14)
Germany’s flagging economy: Build some bridges and roads, Mrs Merkel The Economist (18/10/14)
Germany cuts 2014 growth forecast from 1.8% to 1.2% BBC News (14/10/14)
IMF to cut growth forecast for Germany – der Spiegel Reuters (5/10/14)
Fears of triple-dip eurozone recession, as Germany cuts growth forecast The Guardian, Phillip Inman (15/10/14)
Germany slashes its economic forecasts Financial Times, Stefan Wagstyl (14/10/14)
Merkel vows austerity even as growth projection cut Bloomberg, Brian Parkin, Rainer Buergin and Patrick Donahue (14/10/14)
Is Europe’s economic motor finally stalling? BBC News, Damien McGuinness (17/10/14)
Why Germany won’t fight deflation BBC News, Robert Peston (16/10/14)
Data
World Economic Outlook Database IMF (15/10/14)
World Economic Outlook IMF (October 2014)
Questions
- How do we measure economic growth and is it a good indicator of the state of an economy?
- What are the key external factors identified by the Germany government as the reasons behind the decline in economic growth?
- Angela Merkel has said that austerity measures will continue to balance the budget. Is this a sensible strategy given the revised growth figures?
- Why is low inflation in other economies further bad news for those countries that have seen a decline or a slowdown in their growth figures?
- Why is interdependence between nations both a good and a bad thing?
- Using AS and AD analysis, illustrate the reasons behind the decline German growth. Based on your analysis, what might be expected to happen to some of the other key macroeconomic variables in Germany and in other Eurozone economies?
One of President Trump’s main policy slogans has been ‘America first’. As Trump sees it, a manifestation of a country’s economic strength is its current account balance. He would love the USA to have a current account surplus. As it is, it has the largest current account deficit in the world (in absolute terms) of $481 billion in 2016 or 2.6% of GDP. This compares with the UK’s $115bn or 4.4% of GDP. Germany, by contrast, had a surplus in 2016 of $294bn or 8.5% of GDP.
