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The debate regarding fiscal stimulus over the past year and a half has, frankly, made me despair at the state of the economics profession.
If others believe stimulus spending is a bad idea, fine.
But surely we should expect opponents of stimulus to engage in real debate, which means that they’d have to actually listen, just briefly, to what proponents of the argument are saying – in particular, that the case for stimulus has always been highly dependent on conditions on the ground.
Fiscal stimulus only makes sense when the following two conditions prevail: high unemployment, so that the proximate risk is deflation, not inflation; and monetary policy constrained by interest rates that are very near the zero lower bound.
This doesn’t sound like a hard point to grasp.
But again and again, critics point to examples of increased government spending in completely different circumstances, and then claim that those examples somehow prove their point.
Here’s the latest from New York Times contributor Tyler Cowen, a professor of economics at George Mason University: “Certainly, in Germany, the recent history of fiscal stimulus wasn’t entirely positive,” he wrote in an article published in late July. “After reunification in 1990, the German government borrowed and spent huge amounts of money to finance reconstruction and to bring East German living standards up to West German levels. Millions of new consumers were added to the economy.
“These policies did unify the country politically but were not overwhelmingly successful economically. An initial surge was followed by years of disappointing results for output and employment.”
This passage makes me want to stick a pencil in my eye. Why? Let’s look at Germany’s situation:
1. The example of spending that Mr. Cowen cites was not an effort at fiscal stimulus; it was a supply policy, not a demand policy. The German government wasn’t trying to pump up demand – it was trying to rebuild East German infrastructure to raise the region’s productivity.
2. The West German economy was not slowing due to high unemployment. On the contrary, it was running hot, and the Bundesbank, Germany’s central bank, feared inflation.
3. Low interest rates were not a concern at that time.
In fact, the Bundesbank was in the process of raising rates to head off the risk of inflation — from 4 percent in early 1989 to 8.75 percent in the summer of 1992. In part, this increase was a deliberate effort to choke off the additional demand created by stimulus spending on East Germany.
Also, the German government’s decision to embark on deficit spending while raising interest rates is widely blamed for the European exchange rate crisis of 1992-93, when other European countries with currencies pegged to the German mark were unable to implement corrective policies of their own.
In short, it’s difficult to think of a less relevant case; the example of Germany under reunification does not tell us anything at all about the consequences of fiscal stimulus in our current situation.
And the fact that a prominent commentator on current events apparently doesn’t know that, even after a year and a half of debating this issue, leaves me pessimistic about the economic outlook.
Separate and Unequal
The debt crisis in Europe sparked by Greece this spring did not undermine all euro-zone economies equally. In fact, some have benefited from the growth opportunities that a decimated euro offers, and Germany tops the list.
Germany is Europe’s largest economy – and the world’s second largest exporter after China. For the most part, Germany exports manufactured goods such as machinery and automobiles – goods that are currently in high demand within Asia’s emerging economies, especially by the burgeoning middle classes. The devalued euro has made these goods cheaper abroad and, therefore, global sales of German goods have spiked this year.
But with few growth prospects on the horizon, and weighed down by fiscal austerity measures, the economies of Italy, Greece and Portugal have not fared as well. Countries such as these, lacking Germany’s export opportunities, will have to scramble to remain competitive, not just globally, but within the European Union itself. Tied as they are to the shared euro – and German economic dominance – these countries have little flexibility to do so.
And it’s not only in trade that national differences abound within the euro zone.
In July, a committee of European regulators conducted a series of stress tests on banks to see how they would perform under different adverse market conditions.
While German banks have refused to reveal their full exposure to sovereign debt, nine public sector banks passed the tests despite having lost billions in subprime assets.
Of the 91 banks tested only seven failed — five Spanish banks, one in Greece and one in Germany.
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Paul Krugman joined The New York Times in 1999 as a columnist on the Op-Ed page and continues as a professor of economics and international affairs at Princeton University. He was awarded the Nobel in economic science in 2008.
Mr Krugman is the author or editor of 20 books and more than 200 papers in professional journals and edited volumes, including “The Return of Depression Economics” (2008) and “The Conscience of a Liberal” (2007).
Copyright 2010 The New York Times.