ECB: German Plea Falls On Deaf Ears

When this is all over, and we come to look back at the when and the where, maybe we will remember today’s decision as just one more of those missed opportunities. Certainly not much notice seems to have been taken of Gerard Schroeders request for a helping hand on the interest rate front. Is there any significance in the fact that on the day the ECB decided to stand firm, German unemployment turned upward again to 10.3%, while it was also revealed that German factory orders fell unexpectedly by 2% in January: just for good measure I suppose.

Now before we go any further, I would like to make a retraction. I think it’s only a small one, but still the point is worth making. Back after the last G7 meeting I mildly mocked the joint declaration for highlighting currency ‘volatility’ as the major problem. My point was that I didn’t see much volatility in a movement in one direction only. In fact I was wrong. What we are seeing at this moment is ‘volatility’ as the dollar/euro value constantly readjusts back-and-forth. So even though I would stick my neck out, and go for a continuing upward pressure on the euro, the ups and downs are not without their consequences. This makes business forward planning much more complicated, and obviously is no help to those trying to export.

On the substantive question all eyes need to be on the US labour market. The minor dollar ‘rally’ this week was based on the expectation of a cut in euro interest rates, and a relatively stronger US labour market which would be pushing Greenspan in the direction of raising rates. Well we’ve seen that euro rates are staying put, so now we have to watch how the US data evolves over the next few weeks. My guess is that the $1.30 level will be being tested again before too long, but you never know, I may have got it wrong.

Meantime, and for a change, I’m linking to myself: I just got the latest copy of the Sprout, and here is my article for this month:

German Finances: Much Ado About Something

Germany’s claim that it has its budget deficit under control and that its economy will quickly return to strong growth has recently been put into question by European Commission member Pedro Solbes. In his last assessment of Germany?s updated stability programme, Solbes welcomed Berlin?s pledge to lower its budget deficit, but stressed that differences remained over the “possible rates of growth?. The Commissioner even went so far as to suggest that the economic forecasts produced by Chancellor Gerhard Schr?der’s government are unrealistic, and that in all likelihood Germany will breach the European Union’s stability pact for a fourth successive year in 2005.
Behind all this lies a long-running sore of a problem which divides the Commission and the national governments, a problem where Solbes plays the part of ?villain in chief? for his role as defender of the growth and stability pact. Now that this problem has once more resurfaced it may be worth revisiting it roots.
At the heart of Solbes? most recent jab at Schroeder lies one stark and self-evident fact: Germany is growing old. Forty years ago, just 17 percent of Germans were aged 60 or older. Today, 23 percent are. Forty years from now, the share will be nearer to 40 percent. At least this will be the case if current estimates turn out to be anywhere near accurate. In fact the truth is that we don?t really know what the exact position will be, but there are grounds ? if we look at likely medical and other advances ? for thinking that life expectancy may well be significantly longer than we are currently calculating for.

Now much has and will be written about this topic, but here I would like to focus on three key components of what is going to be an extremely complex situation: demography, technology, globalisation.

As I have said Germany has an ageing population. This is bound to have an important labour market impact as the potential labour force declines, and its average age rises. So what can be done? Well broadly there are three remedies on the table. Firstly increase immigration to replace the lost workers, and in so doing attempt to redress some of the inevitable damage to the support ratio. This road seems highly unpopular, and is unlikely to be explored in any great depth if recent history is anything to go by. Indeed even culturally proximate groups, like the citizens of the new eastern accession countries seem less than fully welcome judging by recent decisions to have an ever receding transitional period for full freedom of movement.

Secondly you can lengthen the working life, from 65 to 70, and then from 70 to 75. The longer life expectancy scenario seems to make this attractive, but the response from those expected to extend their working lives does not appear to be too encouraging.

Thirdly you can increase participation rates: that is the percentage of those below retirement age who continue working. Yet here, once more there seem to be problems. Society at large may agree that this is an interesting objective, but two factors seem to stand in the way. On the one hand the interests of the individual corporate entity. A personal detail here, my wife works for a German multi-national. And do you know what, right now on her boss?s desk lies a proposal to ?recycle? all those employees with over 25 years service. Recycle here is a euphemism for finding a way for them to go through the door. And who can blame the firm. This is a competitive world, and they need to survive. In an era of accelerating technical change, and ever-shortening product and system cycles, rapid reaction on the fly has more value than accumulated wisdom. This means youth. Those valued work-teams of yesteryear, embodying as they did all that accumulated tacit knowledge don?t seem worth what they were. That, of course, is what the structural reforms are all about: asset devaluation. Changing the valuation placed on acquired capacities, in line with the way technical change ?creatively destroys? their value. Nowadays the boss doesn?t cut the quip in the elevator about his most valued asset not being the building but his workforce. No, today?s boss likes to tell his subordinates that his most valued assets are his high-speed broadband connections to cheap bright young minds in China and India. So make no mistake about it, youth brings comparative advantage, and the locus of that advantage is moving, eastwards: this is where the globalisation part comes in. In this sense the split identity we have between the private and the social seems a hard one to resolve.

There is, of course, another way to increase participation rates, and that is to bring more women into the labour market. This objective seems laudable, but is it realistic in an environment where public welfare provision is likely to be severely curtailed? Absent state-financed care, looking after the elderly inevitably tends to fall on the female member of the family. Is caring for an elderly parent with Alzheimer compatible with a high level of active participation in the labour market: I think not. Here we are trying to say that two plus two makes six, and it doesn?t convince.

Which brings us back to immigration, and to Pedro Solbes. One of the few viable strategies for facilitating increased female participation in an environment of dramatic ageing like the one which Germany has in front of it, is to increase the supply of cheap migrant labour, to globalise the internal labour market. On the other hand, as Solbes would I am sure point out, one of the explicit reasons for ?flexibilising? the stability pact was to promote growth, we have flexibilised, and the growth still isn?t coming. Of course we continue to hear that ?I promise it will, but next year?. I?m with Solbes on this, don?t give me pipe dreams, tell me what we are going to do in the here and now to get to grips with the problem. If we don?t do this we may well end up seeing one of those nasty financial crises which would be our worst nightmare. Isn?t it time we had a frank and open debate on all this? When you are living in denial maybe the first step forward is to recognise that you are.

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

5 thoughts on “ECB: German Plea Falls On Deaf Ears

  1. Regarding the US labor market, wage income increased only 1% last year in the US, while GDP increased 4.3%. This is a part of the larger picture of the current US economy, which is largely being driven by a massive surge in household debt, backed by rising asset values, which are in turn being driven up by low interest rates. The causal chain isn’t that hard to follow in either direction.

    The US economy is a good deal more fragile than people are generally willing to admit. Under normal circumstances, the US ought to be buried under inflation right now, and the dollar really ought to be trading for scrap value (if you think the scrap value of paper money is nothing compared to coins, think how intrinsicly worthless an electronic impulse is).

    If the Fed raises interest rates, that entire cycle has to unwind, except that it largely can’t. Housing prices generally can’t decline due the mortgages. Instead, the prices tend to remain static in nominal terms (and the owners unable to move) until inflation catches up.

    It used to be that you could build a “velocity of money” argument around these phenomena, but evidently the definition of the money supply has become so fluid (M1, M2, M3, etc.) that no-one really tries to get a handle on it any more. I haven’t seen one article tracing it’s recent activity in the past six years or so. I also haven’t looked, but I wasn’t looking before then, either.

  2. Schroeder’s pleas remind of this from the Financial Times of 9 February 1998:

    “More than 150 German economics professors have called for an ‘orderly postponement’ of economic and monetary union because economic conditions in Europe are ‘most unsuitable’ for the project to start. The call to delay Emu ‘for a couple of years’ is made in a declaration signed by 155 university professors and sent to the Financial Times and the Frankfurter Allgemeine Zeitung newspaper in Germany. It signals intensified opposition to the government’s euro policy. . . The declaration that ‘the euro is coming too early’ will press the government to explain its policy in economic terms. The statement points to the failure of large European Union states to meet the economic criteria for membership in the Maastricht treaty of 1992 and highlights worsening structural problems. . . ” – reposted at:

  3. “The US economy is a good deal more fragile than people are generally willing to admit.”

    I couldn’t agree more. I also think that Greenspan is now enormously over-exposed. It’s as if he were the last line of defence. The danger is that is he calls too strongly and is found wanting: this could precipitate a complete crisis of confidence.

    “evidently the definition of the money supply has become so fluid…that no-one really tries to get a handle on it any more.”

    If you look at Bernanke’s recent speeches you will find he says that money supply growth is tame and under control.

    In fact if you look at Japan you can see why they aren’t especially worried. The problem is at the other end of the scale, they can pour money in and nothing happens: a kind of monetary ‘black hole’.

    At the ECB under Duisenberg they were still worried about this kind of thing. We are, as usual, rather behind the curve.

    The basic problem is that the monetarist argument doesn’t work, as even Friedman himself has recently recognised.

    Now the really interesting question is why inerest rates are at such historic lows. I will be posting something on this later in the morning.

  4. The problem is at the other end of the scale, they can pour money in and nothing happens: a kind of monetary ‘black hole’.

    Greenspan came up with th ebest analogy for this in 1991-1992 (I have no idea if it was original with him). He described it as “pushing on a string.”

    Obviously, interest rates are staying low because more people want to lend money than want to borrow it. That is almost a tautology. Yet there is at least one large sector (household debt) that is at an historic high. It’s also not that money is pouring out of equities, as the various stock indices are also starting to look a little ridiculous again.

    I may have put the cart before the horse when I assumed that the money supply had become an unreliable statistic, therefore no one was writing about it. Instead, perhaps the money supply has become an unreliable statistic, yet people are still using it to judge future inflation, which is leading to some extremely strange behavior.

    There is always a lot more “stickiness” in monetary (and other) transactions than anyone realizes. The lag times that act as a brake on circulation have a great deal more slack than economists like (it makes theorizing difficult). Every now and again, someone turns up a statistic about that, and it becomes a puzzle. The amount of US physical currency (notes and coins) in circulation outside financial institutions is always an order of magnitude higher than reasonable. In 1990, it was about $770/US citizen, including children and infants (if anyone has access to a more recent statistic, I’d be interested). When you add in uncashed checks and whatnot (I’ve never seen an estimate), the stickiness gets ridiculous.

    There is probably still a lot more of that stickiness left than anyone expects, but there is also probably a lot less than there was a decade ago. That alone could add a lot to the effective money supply without actually changing the money supply. It’s the classic velocity of money argument, only the equilibrium state (which does not drive inflation) is much higher, because tighter inventory/finance controls are now a normal part of business.

  5. That last post is obviously a theory I just threw out. I’m not saying it is right, and I haven’t collected any statistics in it’s defense. But it could be part of the puzzle.

    I have an even better explanation I plan to promulgate elsewhere, but don’t want to repeat myself here.

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