German growth should prompt ECB into action
How worried should we be about a slowdown in the German economy?
Traders working at their desks in front of the DAX board at the Frankfurt stock exchange yesterday. Photograph: Reuters
The German economy’s loss of momentum and its 0.2 per cent contraction in the second quarter has hit the headlines.
However, quarterly swings in growth often contain many distortions and, equally often, are subsequently revised.
The world’s largest economy, the US, shrank by an alarming 2.1 per cent in the first three months of the year . A stunning bounce back in the second quarter resulted in 4 per cent growth.
Both numbers were over-interpreted. The prosaic truth is that the US is trundling along at roughly a 2 per cent pace, perhaps slightly faster: nothing to get too excited about but at least sufficient to generate reasonable jobs growth.
Both the US and German economies were seriously affected by unusual weather during the first six months of 2014. In the case of the US, all of the first-quarter slump can be attributed to bitterly cold weather; the underlying strength of the economy meant that the second quarter was bound to be strong.
By contrast, the German economy was overly strong in the first quarter, thanks to unusually warm weather. So the second quarter was inevitably weak.
ReformsThe underlying German growth rate is probably about 1.5 per cent, possibly a touch higher. That is actually one of the highest trend growth rates in Europe, something that should be giving policymakers sleepless nights. The reforms necessary to raise long-term growth potential are noticeable only by their absence.
Our trade links with Europe mean that while we shouldn’t get too worried about one weak data point, there is little to cheer about.
Germany’s mini-growth miracle of recent years has a number of drivers. Structural reforms that preceded Angela Merkel’s election as chancellor had their effects on her watch. And these effects were observed most noticeably in the labour market where job growth has been enviable.
In addition, as a powerhouse in the production of capital goods, Germany was helped by insatiable demand from China. And, as a producer of luxury goods, especially high-end cars, the rise of the consumer in many developing countries gave a huge boost to German exports.
It is possible that at least two of these factors are now waning: it is now over a decade since Gerhard Schröder enacted his famous reforms and they have not been followed up by anything new.
China is in the process of becoming less reliant on capital spending. Germany which has done so well out of the emerging market boom may not face such favourable economic conditions going forward. Sanctions on Russia and the crisis in Ukraine seem to have prompted a loss of confidence in parts of the German business community.
Consumer boomOne thing that has not happened in living memory in Germany is a consumer boom. Europe has, until now, relied on Germany to prevent renewed recession. But that is a technical point, almost beside the point. The absence of robust German domestic demand expansion means that Germany was never likely to be an engine of economic growth for Europe. No country is going to get rich with a strategy based on exporting to Germany.
Mario Draghi, president of the ECB, rightly argues that those low-trend growth rates are nothing to do with him; they are the responsibility of politicians. But because those structural growth rates are so low, any modest shortfalls, as currently observed in Germany and elsewhere, are going to look like a threat of recession.
The ECB’s implicit job is to ensure that actual growth doesn’t differ too much from trend growth. It is failing in that regard.
The euro area’s potential rate of growth may not be much more than 1 per cent but we are falling way short of even this. Correspondingly, the ECB is failing to achieve its explicit mandate, to keep inflation below but close to 2 per cent.
Current economic conditions mean that the euro area is flirting with deflation, where prices fall. The ECB should, as a result, according to its mandate, embark on more monetary stimulus – quantitative easing.
If the economic newsflow remains grim, it will eventually move, but it will take a lot more poor data from Germany before realpolitik permits the next necessary steps.