Davos: The surprising return of global macropolicies

Roughly ten days ago, I discussed the differences in the policy debates concerning fiscal stimulus on both sides of the Atlantic in this blog, stating that there is an enormous intellectual gap between the European and US debates. While US economists are becoming increasingly comfortable with using discretionary fiscal policies to stabilize the economic cycle, German and European economist are still opposing this idea for fundamental ideological reasons. Some readers, including Daniel Gros, have claimed that the divide is mainly a result of a more sound situation in EMU which still seems to be far away from recession.

During the past days, the debates at the World Economic Forum have now again underlined strongly this policy divide: While leading German economists have been mostly absent from the Davos forum and no senior German cabinet member bothered to show up, at the forum, debates on fiscal policies have even moved one step further: In a panel hosted by FT columnist Martin Wolf (see the webcast), the IMF’s managing director Dominique Strauss-Kahn called for expansionary fiscal policies not only in the US, but also in other countries which have sound budget positions. As the French minister of finance, Christine Lagarde, underlined, this was a quite obvious hint that Germany should opt for fiscal expansion. After all, Germany has reached a balanced government budget in 2007. In addition, as the world’s third largest economy, the country should have enough weight to make a difference even on a global scale.

This shows that transatlantic differences are much deeper than just a slightly divergent assessment of economic conditions. Instead, there seems to be a growing difference in the assessment what macroeconomic policies can and should do. As recently as in the past weeks, leading German economists such as Bert Rürup, the head of the council of economic advisers, and Clemens Fuest again have publicly denounced the idea that one could cut taxes in order to boost the economy. While both agree that at some time in the future Germany should cut income taxes (you can listen to Bert Rürup in German on FT Deutschland’s website here and read Clemens Fuest’s article in German here), they both were very clear that even timing this tax cut according to the need for a fiscal stimulus would be a very bad idea. According to Fuest, empirical experience teaches us that “a debt-financed tax cut might lead to a yoyoing of fiscal policy which can unsettle consumers and investors”. Thus, using tax cuts for cyclical stabilization purposes are a bad idea, writes Fuest. As can easily be seen, this position is light-years away from Larry Summers’ conclusion that he voiced in Davos: “It is important to act at an early state rather than waiting until a vicious cycle has taken place when it is much harder to do something.”

Germany’s economists still seem to be imprisoned in their conclusions from the 1980s that fiscal policy is ineffective at best and counter-productive at worst. In contrast, the global consensus among economists seems to be moving back to the analysis dominant at the G7 meeting in Bonn in 1978, when the largest economic powers agreed on coordinated fiscal policies: At that time, even the German government agreed (along with the French and the British) under international pressure to widen the budget deficit to stimulate domestic demand and help reduce global imbalances. Alas, some economists say the Germans at that time never honored their promise but just labeled some already planned expenditure as being part of the stimulus package. Keynesianism always had a hard time in Germany.

This article has been co-posted at Eurozone Watch.