Germany: Fiscal policy implications for the Eurozone - HSBC

Research Team at HSBC, notes that the Germany posted a record-high fiscal surplus in H1 2016 and is heading for a budget surplus for the third consecutive year and alongside this, its current account has risen to an all-time high of 9% of GDP.

Key Quotes

“This has intensified calls for Germany to stimulate growth by increasing government spending, particularly investment.

The rising surplus is not down to a lack of spending. Government consumption has been increasing by about 4% y-o-y in real terms. In the year to Q2, it accounted for about two-fifths of Germany's GDP growth. However, strong wage and employment growth means revenues are rising faster, while the ECB's QE has contributed to interest payment savings equivalent to around 1% of GDP.

The government has said it intends to give back some of the fiscal windfall to the population in terms of tax reliefs. But it has also said it intends to keep balancing the books even after next year's election. This leaves little room for a meaningful plan to boost public investment which, at about 2% of GDP, is low by EU standards.

Studies from the ECB and the Bundesbank conclude that the benefits of an investment plan in Germany would be significant for both short-term and long-term growth. And while the German economy would be the main beneficiary, the rest of the eurozone would also gain, given the large import content of German investment.

So why is the German government so reluctant? There are legal and political constraints. But there are also more fundamental economic constraints. Germany faces large liabilities due to poor demographics and a generous pension system in the years to come, justifying current fiscal restraints. Some recent policy reforms (e.g. allowing early retirement) have actually made the long-term challenges worse. This could push people to save even more, leading to a 'paradox of thrift'.

It could be argued that Germany is near a cyclical peak, meaning the underlying fiscal surplus is small. Even if this is true, an investment plan could help offset the impact of poor demographics by lifting low growth potential. Higher future growth could also make any stimulus self-financing in the long run. And by lifting growth in the rest of the Eurozone, it could help other European countries maintain the reform momentum, which is also a priority of the German government, but is threatened by the rise in populist euro-sceptic parties. If this momentum stalls, Germany could well end up footing the bill via further transfers.”