Austerity in Germany – A Keynesian Case

The positions about economic policies could not have been more divided between Germany and the US during the latest G-20 summit.

On the one side, Barack Obama pushed Keynesian arguments about the need for further stimulus and the danger of austerity measures for economic recovery. On the other side, Miss “No” is back. Merkel promoted consolidation measures to prevent future debt crises and regain markets’ trust in sustainable government finance. And this time Merkel did not cave into US pressure.

I collected some arguments of why this may be a good idea:

From a free-market point of view, cutting government spending is certainly the way to go when debt financing becomes unsustainable. Less state intervention will give some power back to the market. At the same time, the tax burden does not further increase. Stable government finance can be argued to help building trust in the currency. This could make the risk-averse Germans spend more and save less.

From a Keynesian view, there are mainly three reasons against increased spending in Germany:

1. Private investment demand is up and does not need to be stabilized anymore. There is no ongoing balance sheet recession as most of Germany’s manufacturing companies underwent large scale restructuring in the 2000s and are competitive on world markets.
2. Last year’s fiscal stimulus seems effective as it kept incomes up and people employed. While large spending programs had no effect in the US, the German workers’ subsidy was like a short-term tax cut for companies. A Keynesian could argue that this successfully stabilized the general economy. And as Germany has not seen a domestic consumption boom but rather a production boom prior to the crisis, temporarily subsidizing workers to have them ready to go when the world starts consuming again seems reasonable (from a Keynesian viewpoint). Just as saving is not being contemplated in the US to reduce the current account deficit, German authorities do not want the export engine to sputter.
3. There is uncertainty about the success of the austerity programs in Southern Europe (similar situation to that of California). If they fail due to declines in private spending, which could depress growth and tax revenues, they may face the deflationary-spiral Keynesians always fear. Then the rest of Europe will jump in to safeguard banks and the economies of the south. The larger the deficits are on both sides, the more problematic is the possible bail-out.

Therefore, from a free-market as well as from a Keynesian perspective austerity is in both Germany’s and the EU’s general interest.