© REUTERS/Fabrizio Bensch

Isabel Schnabel is no dove. Germany’s nominee for the European Central Bank’s executive board is eloquent and persuasive; she holds strong opinions, and she knows how to make her views heard in a field still dominated by men. As an economist, Schnabel has often sharply criticized the ECB’s policies, especially its controversial asset purchasing program.

Yet the 48-year-old, who is a member of the influential German Council of Economic Experts, doesn’t represent German monetary orthodoxy. She may disagree with specific aspects of the ECB’s loose monetary policy, but she doesn’t oppose low interest rates on principle. Ideologically, she is probably much closer to the bank’s new president, Christine Lagarde, than previous German central bankers have been.

In addition, Schnabel takes a different view on fiscal policy from many mainstream economists in Germany. In the latest annual report of the Council of Economic Experts, which was published in early November, she gave a dissenting opinion on two key issues of budgetary policy: first, she argued that Germany should lower some taxes and increase public investment to support the lagging economy.

Schnabel’s second dissenting opinion concerned the Schuldenbremse or debt brake that sets strict limits on public deficits in Germany. In the longer term, Schnabel said, this debt brake should be reformed to allow for more public investment.

End of the Balanced Budget?

Such views are increasingly popular in Berlin, where the economic slowdown means that tax income is not increasing as quickly as in earlier years. Chancellor Angela Merkel’s coalition of conservative Christian Democrats and Social Democrats (if it survives, which is an open question) will find it much more difficult than in the past to spend its way out of internal disagreements. The days of a balanced budget seem numbered.

This makes Schnabel a very interesting choice for the German government—and a very different one from earlier appointments to monetary top jobs, Jens Weidmann, president of the Bundesbank and as such a member of the ECB’s governing council, and Sabine Lautenschläger, Schnabel’s predecessor on the bank’s executive board.

Weidmann is the ECB’s most outspoken critic of extremely low interest rates. He served as Merkel’s economic adviser before being appointed to the Bundesbank at the height of the euro crisis in 2011.

At that time, Germans—Merkel’s conservative bloc in particular—were deeply worried about the bailout programs that had been set up to save the eurozone. Risking German taxpayers’ money in order to keep spendthrift countries afloat was extremely unpopular. In that context, a Bundesbank president with strict views on monetary and fiscal discipline seemed like a last line of defense.

Lautenschläger joined the ECB’s executive board three years later, in 2014, when Spain and Portugal had already managed to exit the bailout programs, but Greece and Cyprus were still regarded as vulnerable. Again, Berlin chose a proponent of monetary and fiscal conservatism.

During her time at the ECB, Lautenschläger was as fiercely opposed as Weidmann to continuing the bank’s policy of easy money. While both did have some allies on the governing council, notably the central bank presidents of the Netherlands and Finland, the majority of southern European countries generally backed outgoing president Mario Draghi’s policies.

A Constructive Influence

Lautenschläger stepped down at the end of September, three years before the end of her term, following an ECB announcement that it would lower interest rates even further and resume its controversial asset purchase program. Draghi had pushed through those decisions just six weeks before the end of his mandate, causing an outcry in Germany.

At the time, Schnabel was still a professor at Bonn University, albeit a specialist on eurozone reform and banking regulation, and had no inkling that she might be asked to join the ECB in the near future. Yet in an interview with the business daily, Handelsblatt, she strongly defended the central bank.

“Of course, you can disagree about specific measures,” Schnabel said. “But if politicians, journalists and bankers reinforce the narrative that the ECB is stealing German savers’ money—that’s dangerous. It will come back to haunt us one day.” Schnabel pointed to Britain, where the EU was used as a scapegoat for many years. This was now leading to Brexit, she said. “In Germany, the ECB is constantly being made into a scapegoat.”

Such opinions certainly won’t hurt Schnabel in her new job. More importantly, her differentiated approach toward the ECB’s monetary policy may gain her more influence than Weidmann and Lautenschläger had. Schnabel is a good communicator, and it helps that she is an economist while both Lautenschläger and Lagarde are lawyers by training. If she teams up with Lagarde, the only other woman on the bank’s executive board, both could benefit.

“The ECB’s Executive Board is running out of economic skills,” ING analyst Carsten Brzeski wrote in late October. “With Schnabel, Germany would have an excellent economist on the board, who has been rather supportive of the ECB’s monetary policy decisions of the last years (…) Schnabel could also emerge as a Lagarde whisperer, giving Germany a much better and much more constructive influence on ECB decisions than the traditional nein.”

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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.

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