Germany, expansionary monetary policy, and inflation

There is one thing that the finest salesperson in the world will fail to sell to Germans: inflation, or more precisely, the idea that inflation can be beneficial or desirable or necessary. The steadfast refusal, both in German politics and public opinion, to entertain the notions of a massive quantitative easing or issuance of eurobonds boils down to the fear of inflation. For many Germans, inflation was the evil that brought the Nazis to power: hyper-inflation meant Hitler, ergo inflation is bad, and history has proven to be so.

While economists probably have much more complicated, but also far more accurate, way of describing the problem, many Germans think that if there is more money in Europe because of quantitative easing or eurobonds, and the fiscal situation in other eurozone states remains shaky, then that money will flow into Germany, causing inflation. As Germany is in the euro, it cannot rein in inflation by raising the interest rate, since a high interest rate is not in the interests of other members of the eurozone. In other words: look at what happened in Ireland.

So are Germany and Germans absolutely opposed to any sort of expansionary monetary policies? Some are definitely opposed to any measures, but others are not quite so. In addition to all the problems that a break-up of the euro would cause, Germany has been benefitting from the relatively weak euro, given its reliance on export, so it has no interest in seeing the euro implode. While there are few people who want to go back to the days of D-Marks, they are in a minority. The fundamental question, then, is what price is Germany willing to pay to keep the euro going? Quite a lot, but there are limits: most Germans are utterly fed up of Greece being in the single currency, and they do not want to subsidize other countries’ fiscal indiscipline.

Many Germans want Greece out of the eurozone, because Germans believe that the Greek government had lied through its teeth to join the euro and kept on deceiving once the current crisis started to manifest itself, and then tried to blackmail Germany, by insinuating that a Greek exit from the eurozone will bring about the collapse of the single currency, hence Germany will have to help Greece whatever the costs.

German public opinion takes a very dim view of other countries’ fiscal indiscipline, especially as Germany has made a number of structural reforms. A dodgy geezer to some, Mr Schröder has managed to start a process of reforms, known as Agenda 2010, which has neither been painless nor uncontroversial, but which accounts for German economic resilience in the current crisis. The reform programme created a political consensus of sorts, and Mrs Merkel’s government is arguably a continuation of that reform platform, even if it has split Mr Schröder’s party, the Social Democrats, internally, and from which the party has not fully recovered.

Germany is willing to shoulder the burden to keep the euro in existence, but does not want to prop up a failing state, or others’ structural expenditure, and the resulting fiscal indiscipline. For example, Germany did not raise the age of pension payments, so that other countries can keep a lower pension age. It will not want eurobonds that basically piggyback on German credibility: in other words, other countries borrowing at a cheaper rate on Germany’s credit and guarantee, and continue to spend as if this crisis were a bad dream.

Hazarding a guess, Germany would probably agree to expansionary monetary measures, if they are not used to prop up fiscal indiscipline of other eurozone member states, and if it can exert some measure of control. Germany will insist on austerity of others, but it may be quite willing to bankroll investment in the eurozone. In this respect, eurobonds of certain forms, bonds for infrastructure investment, may suit Germany better, however, there are many issues that need to be resolved. Aside from the questions such as who issues and oversees the bonds, and how the liabilities are divided between the states, there has to be an institution that decides how to allocate or spend the money raised.

Austerity alone is not the solution, even if achieving fiscal discipline is an absolute necessity. There are limits to expansionary monetary policies: the US and the UK are just about floating, despite the massive injection of money through quantitative easing, in addition to low interest rates. Japan has gone through deflation despite expansionary monetary and fiscal policies. The question for Europe is how to manage fiscal discipline, and at the same time find a way to rejuvenate the economy.

If the euro were to survive (minus Greece), then that necessarily means a deeper political integration: there will be a two-speed Europe, in which one consists of the eurozone members, and the other consisting of those that remain outside the eurozone. The currency union cannot survive, in the long term, without a fiscal union, and given the fisc is central to states and politics, a political union. If eurobonds were to be issued, then their institutional basis may well turn out to be the founding institution for a much deeper political integration. Are Europeans ready for such integration, and are there political leaders who can guide that process? The next few months will be crucial.