Wednesday, December 10, 2008

German Economy waits for Gold, Frankincense, and Merkel (A Modern Day Keynesian Controversy)

Despite criticism from leading bankers and other European leaders, German Chancellor Angela Merkel remains defiant on her refusal to spend her way out of the recession, criticising the short-term initiatives employed by Britain, the US and France. Proof of her distinct agitation and non-compliance, if proof were needed, reverberates in her recent joke during a cabinet meeting: “What’s the difference between Communism and Capitalism? Communists nationalised companies first before running them.”

Her blows were swung at the US who she accused of using “cheap money” as a means of fiscal boost and French President Nicolas Sarkozy who voiced his aggravation with Berlin, saying, “While France is working, Germany is thinking.”

The motive for Merkel’s and her Coalition’s’ rebellion is not simply contrarian as might be suspected from the apparent stubbornness of German Finance Minister Peer Steinbr├╝ck “we are not obliged to copy what all other countries are doing,” when he unveiled plans to insert 31 billion euros to help boost the downturn. Rather it is her way of remaining loyal to the “Stability and Growth Pact” (SGP) originally proposed by the former Finance Minister Theo Waigel at the beginning of the 1990’s and agreed at the EU summit in Dublin in 1997.

The purpose of the pact – that has the backing of both Merkel’s Christian Democrats and Steinbr├╝ck’s Social Democrats – was to tune the euro so it would be able to compete with the US Dollar and strengthen the stability of the euro-zone. It has strict criteria which is the fountainhead of the present dispute.

Merkel also contends whether the aid for Commerzbank – the first commercial lender to seek Governmental capital - meet the terms of the 500bn euro rescue fund, approved by the EU, adding "Europe must, I say this clearly in relation to the German bank rescue package, act speedily".

The way other European leaders have tackled the financial crisis and the nature of Merkel’s rebellion should provide analysts with lessons of a modern day battle of Keynesian economics and its antagonists (It will be of no surprise that the SGP has its roots in the Keynesian-Monetarist controversies of the 1960’s-1970’s). The picture painted of Merkel by her critics as “faint-hearted” has been due to the perceived weakness of her stimulus plans, which amount to €11bn over two years, a mere pinch on the €480bn used by the by government as bank rescue.

Whereas the fashion is to stay true to Keynesian economics, namely book IV of Keynes’ General Theory entitled “Inducement to Invest” which instructs a reduction on interest rates and allowing a minimum of capital efficiency in order to promote governmental investment, Merkel has put Germany’s brakes on.

To critics that appeal to the lack of quick and effective relief in 1929 such as Peter Coy of Business Week, Merkel has claimed that the crisis cannot follow “an old script we can turn to”. Save for the extraordinary parallels Merkel’s plans have with the SGP and the clear reaction to the neo-Keynesian approach taken by her European peers – plans akin, in other words, to a script – the dispute does make for an interesting battle of economic theory in practice, and could be a decider for future crises.

Like Ela Soyemi for The Guardian has rightly pointed out “it is worth taking a good hard look at Merkel’s point.” In spite of financial hard times, conclusions may be drawn for the most appropriate action a government should take – fiscal boosts or hands on heads.

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