Why a slowdown in Germany could be good for Europe

Francesco Giavazzi, Alberto Alesina, 1 September 2011



Paradoxically, the slowing down of the German economy could be a blessing for the euro – and a boost to the probability that the euro survives the crisis.

Until a few weeks ago, the Eurozone economies seemed to be moving in different directions.

  • Germany was growing at a swift rate with a solid fiscal stance.
  • The southern economies (Greece, Italy, Spain, and Portugal) were – and still are – not growing and in a fiscal mess.

This situation created headaches for the ECB.

  • Monetary policy appropriate for the German economic cycle would mean slowly-rising interest rates and an end to adding extra liquidity to the system by buying the Treasury bills of various Eurozone countries.
  • Monetary policy appropriate for the weaker economies, by contrast, would mean buying more governments’ bonds – a move that would anger Germans who do not see this as the ECB’s proper role.

Now, with Germany slowing down, a more “relaxed” monetary policy may become more acceptable, even for the Germans.

Relaxation of tensions = window of opportunity for reform

The markets seem to have figured this out. The relaxation of tensions has seen a stabilisation of the spread between yields on weak countries’ bills and those of the German government. The euro has also slightly depreciated.

This situation offers a window of opportunity for southern countries to reform. The financial emergency is a force which can help politically with difficult reforms. The possibility that the ECB might slightly relax its monetary stance creates a unique opportunity. The time for action is now.

Time to face the facts

We should stop thinking that the euro can be saved with some financial trick. Every day we hear some economist or policymaker proposing a new, ever-more clever financial scheme to overcome the crisis.

All these schemes share the idea that a solution can be found without hard and immediate choices in the problem countries, and without costs (except, perhaps, for Germany). The most commonly-advocated financial scheme is Eurobonds. But let’s start calling them by their real name – a German guarantee on Italian and Spanish debt. Once their real nature is clear, should we be surprised if the Germans are not enthusiastic about them?1  So let’s stop kidding each other with dreams of Eurobonds. Let’s start talking about fiscal rigour and growth in the weak economies.

Tackling fiscal problems

Fiscal rigour and growth are domestic problems. There is very little that the EU or the ECB can do to make, say, Italy grow with lower debt. Fiscal discipline might be helped by introducing fiscal rules into national constitutions. A balanced budget rule has pros and cons.

  • The pro is obvious: a credible, long-run commitment.
  • The con is the rigidity that such a rule imposes.

Fiscal deficits are not evil in themselves. Indeed, deficits are necessary and desirable in certain circumstances. This fact is what creates the big political problem.

One possibility is to have constitutional rules that focus on cyclically-adjusting budget balances. But then how could we avoid ingenious ways of correcting the deficit for the cycle? Soon, higher deficits would be defined as cyclical even when they have nothing to do with the cycle. The creativity of fiscal account is well known.

One possibility would be to empower an EU institution – say Eurostat or the ECB – to make the cyclical adjustment. But can we really expect national parliaments to delegate such powers? This is the problem of fiscal rules:

  • Either they are very rigid, or
  • they are not fully enforceable.

Nevertheless, some domestic rule is probably a necessity which, although imperfect, may help.

The growth priority

The other priority is growth. The litany of pro-growth market-friendly reforms for European countries is so well known that it hardly bears more than a quick list here. The litany differs somewhat across countries, but it usually involves labour-market reforms, privatisations, cuts in wasteful government spending, decreased regulations, and so on. What the list should not include is more physical infrastructure – a useless European obsession.

Citizens of the problem countries – and the Eurozone more generally – need to decide whether they want to grow or not. They don’t have to grow, they could just survive. A slow decline that eats away Europe’s wealth is possible. This banquet would bequeath a mess to their children but, as Keynes said, in the long run we are all dead.


Gros, Daniel (2011). “Eurobonds: Wrong solution for legal, political, and economic reasons”, VoxEU.org, 24 August

1 Also see Gros (2011) on this point.

Topics: EU policies, Europe's nations and regions, Monetary policy
Tags: ECB, Eurozone crisis, Germany

Nathaniel Ropes Professor of Political Economy, Harvard University; and Research Fellow, CEPR

Francesco Giavazzi

Professor of Economics, Bocconi University; and Research Fellow, CEPR

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