A bimonthly magazine on international affairs, edited in Germany's capital

Red Herring & Black Swan: Rally Behind the ECB


Instead of complaining, Germany and others need to back up the European Central Bank by investing in infrastructure and technology―and by letting go of their unhelpful obsession with fiscal prudence.

Following the European Central Bank’s announcement in September that it will restart its bond-buying program, several national central bank governors voiced unprecedented public criticism of the decision. “In my view, [outgoing ECB president Mario Draghi] has gone too far,” Bundesbank chief Jens Weidmann told German tabloid BILD. A group of former central bankers quickly followed with similar complaints.

All this comes on the back of strong condemnation in recent years of the eurozone central bank’s monetary policy from parliamentarians and other officials, particularly in countries such as Germany and the Netherlands.

The issue is not just that this damages public trust in the independence of the ECB. Such objections also tend to ignore the source of the current low-rate environment. For example, the ECB is constantly under fire in Germany, even though the German government’s unwillingness to spend and invest more has played a role in forcing Europe’s central bank to intervene and in keeping interest rates low. Criticism of the ECB coming from those in charge of fiscal policy is particularly galling because, over the last decade, the eurozone has relied almost completely on support from the ECB to stimulate its economy.

Too Much Saving

The ECB’s critics complain that it keeps interest rates artificially low, causing savers to lose out, distorting markets, reducing pressure on governments to reform, and putting pressure on banks’ business models and on pension funds’ funding positions. However, they tend to ignore the causes of the low interest rate environment and overstate the power of the ECB to control financial conditions. This critique also disregards the fact that interest rates have been on a downward trend since the 1980s. In fact, this trend in rates continued largely unchanged after the start of the ECB’s bond-buying program in 2015. Nevertheless, critics tend to blame this practice, which they often incorrectly describe as “money printing,” for the current state of financial conditions.

The bottom line is that too many people, and countries, are trying to save more than they invest. And as the demand for borrowing is lower than the supply, the price of borrowing, i.e. the interest rate, is falling. This is clearly visible in the eurozone, which as a whole consumes and invests significantly less than it produces, with the gap at about 3 percent of its gross domestic product. Ageing populations are often assumed to be a driving factor of this; a relatively larger group has to save more for their retirement. The fact that so many investors are searching for safe assets, often government bonds, pushes up their prices and thereby reduces their yields. On top of these private sector savings, many European governments are now running fiscal surpluses, further decreasing the supply of safe assets and pushing up their prices.

Counterproductive Fiscal Policy

While the ECB will never acknowledge that it has run out of tools to stimulate the eurozone economy, its repeated calls for government spending highlight that it cannot do the job alone. For several years now the ECB has been pointing out to governments that it needs support from fiscal policy to boost economic growth in the eurozone. But many governments have responded by doing the opposite: tightening fiscal policy, and in many cases running large fiscal surpluses for several years, often by increasing tax burdens and cutting back on public investment.

In spite of repeated calls for Germany to loosen the purse strings, including from the IMF, both governing German parties remain committed to the so-called “schwarze Null policy” of making no new debt. Olaf Scholz, the finance minister, recently indicated that Germany would be willing to increase spending in the event of a crisis comparable to that in 2008, but this sets an absurdly high bar—that was, we hope, a once-in-a-generation global economic crisis.

Germany did engage in fiscal stimulus during the global financial crisis in 2009-10, but this turned out to be a short-lived experiment. By 2011, it was already tightening again. That fiscal stimulus helped the German industrial sector through the slump, and Berlin might repeat the trick now to cushion the impact of the current industrial downturn, for instance through state support for reduced working hours. This would be welcome in the short term, but it runs the risk of crowding out the types of spending and investment needed for the medium to long term. Under the schwarze Null, every euro spent paying factory workers to stay at home is a euro not spent renovating schools, or improving low-carbon transport.

How to Kick the ECB Habit

Unemployment may be approaching historically low levels in the eurozone, but the persistence of low inflation points to a continued demand deficit. The ECB under Draghi has responded to this, but governments have barely contributed to these efforts. Through increasing spending, particularly investment, they could help create the conditions that would allow interest rates to be increased. Instead, some are calling on the ECB to tighten policy now in the same disastrous way it did in the past, unnecessarily cutting short economic recoveries.

There have been some tentative calls even from influential voices within Germany to increase spending, with the idea usually being to invest more in areas such as green technology. While this would be a good step, Germany and other countries in comfortable fiscal positions need a change in thinking, need to increase investment on a wider scale. Due to the current healthy state of its public finances, for Germany this would not even necessarily mean going beyond the headline budget targets set out in the European rules or violating its constitutional debt brake, which—unlike the schwarze Null—allows limited debt spending.

Beyond the modest positive economic spillovers to the rest of the eurozone, doing so could also encourage the bloc to rethink its fiscal rules. These could be made more accommodating to public investment in order to avoid situations in which governments cut down on this to reach headline budget targets. Such a shift in attitudes towards fiscal policy would be difficult to achieve, not least because the opposition to spending is not just driven by ideological considerations but also simply resonates well with many electorates. However, taking a new approach could help ease relations between the member states and could be achieved without letting go of prudent fiscal management altogether.

Europe needs investment in infrastructure, education, digital technology, and research to get it ready for the future and to boost the competitiveness of some economies, particularly peripheral ones. Public investment fell from 3.3 percent of eurozone GDP in 2008 to 2.7 percent in 2018. This is partly the result of secular spending pressures, as ageing populations pushed up healthcare and pension spending, but also of deliberate prioritization by policymakers.

In pursuit of these targets, European governments ignored investment in the long-term strength of their economies. Now that government bonds carry negative interest rates, and governments are thus effectively being paid to borrow, there is no excuse to continue to do so. Only by letting go of the arbitrary fiscal targets and stimulating investment and consumption demand in the eurozone can governments get Europe’s economies to a position where the ECB is able to withdraw its monetary policy support over time.