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It’s Time for German Fiscal Expansion

Summary:
The United States has made some bad fiscal choices, in particular by cutting taxes for the rich at the peak of the business cycle. German policymakers should not make the symmetric mistake of preserving the country’s budget surplus as the economy risks sliding into recession. CAMBRIDGE – As long as Germany’s economy was recovering well from the 2008 global financial crisis, policymakers had a coherent rationale for fiscal austerity. Rejecting other eurozone countries’ constant urging that they undertake stimulus, they enshrined the national commitment to budget discipline in the 2009 “debt brake,” which limits the federal structural deficit to 0.35% of GDP, and in the subsequent schwarze Null (“black zero”) policy of

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The United States has made some bad fiscal choices, in particular by cutting taxes for the rich at the peak of the business cycle. German policymakers should not make the symmetric mistake of preserving the country’s budget surplus as the economy risks sliding into recession.

CAMBRIDGE – As long as Germany’s economy was recovering well from the 2008 global financial crisis, policymakers had a coherent rationale for fiscal austerity. Rejecting other eurozone countries’ constant urging that they undertake stimulus, they enshrined the national commitment to budget discipline in the 2009 “debt brake,” which limits the federal structural deficit to 0.35% of GDP, and in the subsequent schwarze Null (“black zero”) policy of fully balancing the budget.

More German public spending, stimulus advocates argued, would reduce the country’s huge current-account surplus and fuel demand that would help other eurozone members, especially in southern Europe. But with Germany experiencing low unemployment and relatively strong growth, policymakers in Berlin were understandably afraid that such measures would cause the domestic economy to overheat.

Today, however, overheating is no longer the concern. German GDP growth turned negative in the second quarter, reflecting weakness in the trade-sensitive manufacturing sector. And if third-quarter growth also turns out to have been negative, the economy will officially be in recession.

Slower income growth will depress tax receipts and thus reduce Germany’s budget surplus. But the authorities should certainly not take steps to preserve the surplus. On the contrary, the government should respond to any slowdown by increasing spending and/or cutting taxes. In particular, it should spend more on infrastructure maintenance and modernization, and it could cut payroll taxes.

The legal constraints of the debt brake may limit the size of the stimulus, but they still leave some space. Moreover, the full “black zero” could be set aside in case of recession. Or it could be reinterpreted to...

Jeffrey Frankel
Jeffrey Frankel, a professor at Harvard University's Kennedy School of Government, previously served as a member of President Bill Clinton’s Council of Economic Advisers. He directs the Program in International Finance and Macroeconomics at the US National Bureau of Economic Research, where he is a member of the Business Cycle Dating Committee, the official US arbiter of recession and recovery.

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