THE ECONOMIC CONSEQUENCES OF MERKEL MARK THREE / THE FINANCIAL TIMES COMMENT & ANALYSIS

September 23, 2013 6:59 pm

 

The economic consequences of Merkel mark three

 

By Wolfgang Münchau

 

Crisis-resolution will take the form of ‘pretend and extend’. Nothing will be resolved

 

©AP

 

 

Angela Merkel owes this weekend’s electoral success to her ability to persuade voters she is a safe pair of hands in economic policy. In this, several German commentators have drawn parallels with the 1957 campaign of Ms Merkel’s Christian Democrat predecessor Konrad Adenauer, who secured an absolute majority with the slogan: “No experiments”.

 

It may appear intuitively true that a safe pair of hands balances the budget each year; refuses to accept bailouts, let alone forgive debt; and rejects joint-liability instruments on the grounds that they encourage overspending. But look a little bit deeper and it is clear that recent history is full of examples of what happens when you force excessive austerity during a recession; postpone an inevitable debt restructuring; or delay an inevitable recapitalisation of a banking system.

This is not really the work of a safe pair of hands. On the contrary, this is unbelievably reckless. You might even call it, to use Adenauer’s term, an economic “experiment”. The opposition parties failed to communicate this point. Sheer incompetence meant they did not deserve to win this election.

Ms Merkel’s victory will have three consequences for economic policy. First, and most important, the approach to crisis-resolution – or non-resolution – will not change. Some investors have expressed the hope that she will accept what is known in the jargon as “official sector involvement” – allowing some of the debt to be forgiven. This is not going to happen. Some want the European Central Bank to write off parts of the debt it holds as part of its refinancing operations. I do not think this is likely either, given the hostility of the German public, the Bundesbank and possibly the German constitutional court to any form of monetary financing of government debt. Crisis resolution through any form of debt forgiveness has no legal basis in the EU and is a political minefield.

 

My guess is that crisis resolution will increasingly take the form of what banks would call “pretend and extend”. You extend the maturity of the loans, reduce the interest rates and pretend your credit is still whole. It lacks transparency and it is undemocratic. In the eurozone crisis, the logical limit would be to extend the maturity of the loans to infinite and reduce interest rates to zero. They will probably stay clear of this limit but the net present value of the loans will have to fall. So there will be a third Greek programme, a second Portuguese programme, and then fourth and third programmes respectively. Everything will be revolved. Nothing will be resolved.

Second, Ms Merkel’s victory will leave the general approach to macroeconomic policy unchanged even if, as I expect, she enters a grand coalition with the Social Democrats (SPD). One should never underestimate the SPD’s tendency towards orthodoxy when in government. The party will continue to support the current restrictive fiscal policy stance in the eurozone.

 

It will, in particular, reject the idea that Germany should use its fiscal leeway to counterbalance austerity in the south. It will use solid legal arguments.

 

Everyone in the eurozone signed up to the fiscal compact, which forces all of them to run tight fiscal policies to reduce debt ratios. There is no provision in those laws and treaties that allows countries to postpone debt reduction over a sustained period for the sake of a better macroeconomic policy mix. The lack of such provisions is no accident.

Most recently, the pace of austerity has slowed a little, which is the main reason the eurozone is slowly emerging from recession. But, since fiscal targets are slipping, I expect fiscal policy to tighten again next year. We are already seeing this in Italy.

The third economic effect of the Merkel victory is that it postpones the moment when the SPD will return to a more macroeconomic perspective. This may still happen but not in the next four years. My guess is that the party will broadly support Ms Merkel’s orthodox policies in exchange for a few pork barrel-type spending commitments on causes it holds dear.

 

The SPD never recovered politically from the leap into supply-side economics under Gerhard Schröder, Ms Merkel’s predecessor as chancellor. It exorcised Keynesianism just at the moment when Europe needed it the most.

Now likely to be stuck in a grand coalition, the SPD will for the next four years continue to support the current policy framework. It is in the nature of grand coalitions that the joint opposition is weak.

The two parties likely to be in opposition are the Greens and the Left party. Both are more macroeconomically focused, but they are small and have limited influence on the debate.

So if you were hoping for a safe pair of hands, it looks like you got what you wanted. Be careful what you wish for.

 

Copyright The Financial Times Limited 2013.