Jürgen Stark: Economic perspectives in the euro area and Germany
Lecture by Dr Jürgen Stark, Vice President of the Deutsche Bundesbank, at the dinner with The
Money Marketeers, New York, 25 February 2004.
* * *
I
It is an honour and a pleasure to have the privilege of addressing you here today on the economic
perspectives for Germany and the euro area as a whole.
As a central banker, I prefer not to focus on the change in the latest monthly sentiment indicators and
on quarterly growth figures, but rather on longer-term issues which are essential for a stability-oriented
monetary policy, for potential growth and for an economy's resilience to shocks. I shall also be
highlighting some differences and similarities between economic fundamentals in Europe and the
United States.
European economic and monetary union (EMU) is now in its sixth year with the euro as its single
currency. These years have been fairly demanding but despite a number of sizeable adverse shocks,
the Eurosystem, which consists of the European Central Bank and the euro area national central
banks, has managed to deliver a credible monetary policy stance.
In the run-up to EMU and at its outset, many sceptics queried the feasibility of an "one-size-fits-all"
monetary policy with a decentralised but closely coordinated economic and budgetary policy. The area
was seen as too heterogeneous for such a demanding regime.
Such criticism has become less vociferous recently due to the monetary policy track record, which
proves that the credibility test has been passed so far. Average inflation has been close to 2% and
long-term inflation expectations have been well contained, being close to and mostly below our ESCB
definition of price stability of below 2%.
The growth performance of Germany and the euro area as a whole has been less encouraging.
However, after three years of sluggish growth, the region is finally showing increasing signs of a
moderate cyclical economic recovery.
The underlying conditions for strengthened economic growth remain favourable. Financing conditions
are generally supportive, with low nominal and real interest rates. The restructuring of corporate
balance sheets, particularly in Germany, has made considerable progress. Robust growth in our major
trading partners is also aiding the economic recovery process.
The favourable impact of world trade and world growth dynamics are more important for our exports
than the recent decline in price competitiveness caused by the appreciation of the euro. The debate
on the potential adverse effects of a stronger euro should not distract us from the real underlying
obstacles to growth in Europe.
I would not be sketching a full picture of the economic outlook if I failed to mention the risks to the
broadening global recovery. Four factors, in particular, have to be watched carefully.
Firstly, global imbalances, especially the persistent US current account deficit. According to the
OECD, it is likely to surpass US$600 billion in 2005, which is equivalent to more than 5% of GDP. The
deficit is growing both in dollar terms and relative to the size of the economy. What does that mean?
Why was it not an issue years ago and why is it an issue now?
Basically, the answer to those questions is that the source and the financing of the deficit have shifted
from the private to the public sector. From an US perspective that is not a problem as long as
foreigners are willing to continue supplying their savings. But the composition of external financing is
becoming unbalanced and, to a growing extent, it is relying on foreign central bank purchases of US
Treasuries. The willingness of overseas investors to hold an ever-growing dollar-denominated portfolio
is obviously something which cannot go on for ever.
Secondly, protectionist pressure. When Alan Greenspan spoke about globalisation last month at the
Bundesbank Lecture 2004 in Berlin, he reminded us of the virtue of open markets. He stated: "it is
imperative that creeping protectionism be thwarted and reversed".1 This insight comes as no surprise
to an economist, but it is a message which is easily forgotten. Unfortunately, that is something which
holds true on both sides of the Atlantic. Withstanding archaic reflex responses of emerging
protectionism is sometimes a quixotic experience. But we should never forget that open markets and
free trade in a multilateral world are key to prosperity - on both sides of the Atlantic.
Thirdly, large fiscal deficits in all major economic regions and increasing debt-to-GDP ratios. It cannot
be ruled out that this worldwide deterioration of fiscal positions will sooner or later lead to market
reactions. An appreciable rise in interest rates has to be expected when investors begin to doubt the
longer-term sustainability of public finances.
Finally, ample liquidity. That is to say the gap on a global scale between real money growth and real
GDP growth. This excess liquidity nurtures the risk appetite of investors. The search for yield has led
to a considerable narrowing of corporate bond and emerging market sovereign spreads. If excess
liquidity is not mopped up at some point in time, it will find its way through in terms of pushing up
inflation or in feeding new asset price bubbles which could be costly to unwind.
II
The global economic recovery is at present mainly driven by two centres of gravity: the US economy
and emerging Asia. The euro area is lagging behind. Why has growth performance in the euro area
and Germany been so sluggish during the past few years?
Growth differentials between the United States and the euro area are for the most part a non-cyclical
phenomenon. For instance, the estimates of overall production potential differ significantly.
The US experience might hold important policy lessons in this regard and we have had quite a lively
debate in Europe about the need to become more like the United States. In a nutshell: this is about the
contest between the pros and cons of the Anglo-American free market model and the European model
of social cohesion. I shall try to remedy certain misunderstandings or misperceptions that arise when
country-specific factors are compared.
The latest growth figures for the United States are impressive. However, when thinking in terms of
prosperity developments, it is necessary to apply a per capita assessment. A country with a
fast-growing population needs to generate a greater increase in real income than a country with a less
rapidly expanding population if it wishes to maintain or even increase the prosperity of its citizens.
The euro area's annual population growth between 1996 and 2003 was about 1⁄4% (in Germany about
0.1%), whereas the US population grew by an average of about 1% owing to its higher birth rate and a
sizeable influx of immigrants. Thus, the annual real GDP change of 2.0% in the euro area (1.2% in
Germany) and 3.3% in the US in per capita terms was 1.7% in the euro area (1.1% in Germany) and
2.2% in the US. The per capita growth differential is therefore "only" roughly one-third of the overall
figure, which could be narrowed down further if methodological differences regarding the
measurement of deflation and depreciation were to be incorporated.
The smaller per capita difference by no means justifies complacency. However, it is a better reflection
of the improvement that has been achieved in the standard of living. It still shows that the per capita
growth gap between the USA and Europe is growing and not converging. And one also has to take
into consideration the fact that the United States is already at a considerably higher level. In 2002,
GDP per capita on the basis of purchasing power parities was one-third larger in the United States
than in the euro area.
What are the main elements behind these developments? Lower GDP per capita means lower
national living standards. Economic well-being is largely determined by productivity. Looking at labour
productivity, it is striking that the factor labour is not very efficiently incorporated into the production
process in Europe.
The labour force participation rate in the euro area - that is the members of the workforce in relation to
the population of working age - is about 68% and more than 8 percentage points lower than in the
United States.
Labour utilisation in Europe and Germany has declined significantly, mainly due to three factors.
1. The preference for shorter working weeks and longer holidays. Working hours per person
employed during the last 25 years have remained virtually unchanged at around 1,800 hours
per year in the United States, whereas in Germany, the average number of hours that
employees work is now around 1,450 hours, which is 15% lower than 25 years ago.
2. Withdrawals from the labour force, including high participation in early retirement schemes
since the early 1980s. The average retirement age at present in Germany and France is
about 59 years.
3. The rise in unemployment, since the late 1970s up to 8.8% of the labour force.
An interim conclusion may be drawn from this: the once popular European belief that the distribution of
a presumably fixed amount of labour would lead to greater work opportunities has not become a
reality. On the contrary, it has led to higher non-wage labour costs and higher taxes, which have
become an impediment to economic growth and job creation.
Labour productivity per hour worked is at present about the same in the United States and in
Germany. However, since the mid-1990s, increases in hourly productivity have been lower than in the
United States. According to an OECD study,2 the main factors behind this have been a smaller-scale
use and slower diffusion of information and communication technologies (ICT) and less intensive
research and development. Other factors that play a role are institutional differences such as labour
market rigidities and the relatively entangled web of regulations.
Taken together, this has resulted in a hard core of structural unemployment. In particular, Europe has
been less successful than the United States in integrating "marginal" or less productive members of
the labour force into the economic process. A better inclusion of this part of the labour force might
transitionally slow down changes in labour productivity, but would still increase overall welfare.
Of course, the available data have to be interpreted with caution. Statistical sources vary and societies
have deep-seated structural and cultural differences which make any comparison difficult.
Nevertheless, despite all terminological, conceptual and empirical difficulties, cross-country
comparisons still remain important indicators for evaluating policy measures.
Last but not least, lower productivity per employee than in the United States is, in part, a reflection of
the democratic choice or the preference of European societies for shorter working time, which is, in
economic terms, a substitution of consumption opportunities through leisure. However, this should not
be interpreted as economic inefficiency. It could also be argued that US workers have had to work
longer hours than their euro area colleagues to maintain similar per capita growth rates.
Occasionally, it is suggested that not only material living standards should be considered but also
other indicators of welfare, as Robert J. Gordon has done.3 According to his analysis, the GDP of the
United States is bloated due, for instance, to the huge cost of keeping more then two million residents
in prison and jail (700 inmates per 100,000 residents, whereas Germany has about 80 inmates per
100,000 residents), the higher primary energy consumption per capita owing to the more extreme
climate (energy consumption in Germany per capita is about half as high) and elevated transportation
costs on account of the greater dispersion of the US population.
These factors boost GDP without creating more welfare. I am not willing to make a value judgement
on these issues. Nevertheless, those factors should be kept at the back of one's mind when
comparing developments in GDP.
III
In Germany, three years of an almost stagnating economy have led to the so called "Rhineland model
of capitalism" being subjected to more intense scrutiny. This development has not only raised
questions about the economy, but also about German society and its political system.
The late Rudi Dornbusch once described Germany as an economy with two faces.4 On the one hand,
an immensely successful country, prosperous and stable, with among the highest living standards in
the world. On the other hand, a country that is plain stuck with mass unemployment, slow growth, with
no idea of what to do about it and even less courage to try. I don't believe that the last two criticisms
still hold true.
Less than a year ago, the situation had become so serious that the Bundesbank felt impelled to take
an unusual step for a central bank in publishing a reform strategy based on a thorough analysis. To
overcome the prevailing crisis of confidence, we called for a coherent overall approach to structural
reform in the labour market, the social security system and fiscal policy.
The momentum for reform is almost tangible. The government has already started to implement a
number of important measures of its Agenda 2010. This is designed to increase, over time, the growth
potential of the German economy and includes
- labour market
- pension system and
- health care
reforms. The objective is a more flexible economy and to bring the social security system more in line
with economic capacity.
It is imperative that corrective measures be implemented in a timely manner. Unfortunately,
experience shows that in the political sphere often more than 20 years pass by between awareness of
social and economic challenges and their being addressed. Not to mention the difficulties in gaining
popular support for or mere acceptance of structural changes.
However, policy must not be confined to the "art of the possible". Policy is also the art of making
possible that which is necessary.
The general public is beginning to realise that the deep-seated German proclivity for consensus does
not work in an environment of low growth rates. Much remains to be done and it is crucial that this
impetus does not falter.
The structure of Germany's constitution with its different layers of checks and balances makes it
difficult to obtain the large parliamentary majorities needed for implementing daunting reforms. This
pronounced decentralised system is firmly rooted in German history. It did not hamper the enormous
economic upswing in the second half of the last century, but it has encountered difficulties in coping
with the changes that have become necessary owing to reunification, European integration,
globalisation and demographic challenges.
IV
Structural change is possible in Europe. The most convincing recent example is European economic
and monetary union. The creation of a single European currency was the most far-reaching and
challenging monetary event to take place since the Bretton Woods conference in 1944 and the
changeover to flexible exchange rates in the early 1970s. The true dimensions of this political project
are often underestimated. The same is true of the economic benefits that will materialise over time.
A monetary union has to be grounded in shared values. The basis of those shared values is the
definition of the member states' economic policies enshrined in the Maastricht Treaty as the principle
of an open market economy with free competition.
However, another fundamental policy decision was also necessary for the introduction of a single
currency, namely the willingness to transfer national monetary sovereignty to a supranational
institution. The concomitant renunciation of sovereignty signified a profound break with the historical
and political self-perception of the EU member states.
European economic and monetary union was possible only against a backdrop of shared traditions, a
decades-long process of integration and successful convergence in the 1990s. The opportunity to
create a single European currency unleashed great energies in the EU member states. In that process
of convergence, inflation rates, interest rates and government debts were reduced to the benefit of the
participating economies.
Given reliable underlying economic policy conditions, exchange rate relationships on the foreign
exchange markets within Europe were able to stabilise. Those countries which used to have weak
currencies gained especially from this since their risk premium on capital market rates decreased
appreciably.
Overall, economic and financial policy has become more geared to the medium term and more
predictable as a result. Essentially, this means that the member states have said goodbye to the
stop-and-go policy that often used to be pursued.
Despite differing economic policy standpoints and traditions, it was possible to develop and put in
place a joint stability-oriented strategy for economic and monetary union. That would not have been
possible without political courage and the will to shape events.
At this juncture, let me introduce another institutional pillar of European monetary union: the Stability
and Growth Pact, which aims to limit the risks to price stability which might otherwise arise from
national "free rider" fiscal policies.
From a macroeconomic stabilisation perspective, the central budget of the European Union, at roughly
1% of EU GDP, is insignificant in Europe. The crucial stabilising role compared with the US
government expenditure of 34% is played by the national budgets of the member countries, whose
general government expenditure accounts for 48% of euro area GDP.
That is one reason why EMU needs a counterweight to the politico-economic incentives to borrow
without being penalised adequately by financial markets in terms of a higher interest rate premium as
compensation for the national inflation and depreciation risk. The Stability and Growth Pact is
therefore also an insurance policy for countries which adhere to sound fiscal policies.
This framework for fiscal discipline makes long-run sustainability of public finance and short-term
stabilisation compatible. The objective is to achieve a medium-term budgetary position close to
balance or in surplus. An additional rationale for the Stability and Growth Pact is the urgent need to
take account of the unfavourable demographic trends in Europe. Such a trend exists in the United
States as well, but is less pronounced. By 2050 the share of elderly people (≥65 years) in the
population will have gone up from 12% to 21% in the United States and from 16% to 28% in the EU.
Within the fiscal framework of the Stability and Growth Pact, the automatic stabilisers are allowed to
operate freely as long as the upper ceiling of the 3% deficit is not endangered. The higher general
government ratio in Europe and the structure of social transfer payments make the automatic
stabilisers twice as effective as in the United States. As a result, discretionary fiscal policy and all its
well-known pro-cyclical drawbacks are less of an issue.
However, some governments' degree of commitment to the rules and procedures of the Stability and
Growth Pact has not been encouraging recently. The credibility of the framework has been cast into
doubt. This development is jeopardising confidence in the sustainability of public finance in the euro
area. European and especially German consumers seem to be more Ricardian in nature than
American consumers are. That is to say, they have lost confidence in the soundness of public finance
and they tend to regard higher deficits today as higher taxes tomorrow, therefore increasing their
savings and holding back on consumption.
Occasionally, the monetary policy of the Eurosystem is blamed for the slow growth performance of the
euro area. By the same token, it is acknowledged that the ECB is only fulfilling its mandate.
Consequently, it is argued that the mandate should be changed and reflect more the goals of the
Federal Reserve System. I believe this line of reasoning is rooted in unfamiliarity with fundamentals
within the euro area. But let me also raise two important questions.
1. What is the role and focus of monetary policy?
2. What can be achieved through monetary policy?
In answering these questions allow me to make the following points.
Firstly, the primary focus of European monetary policy is on maintaining price stability over the
medium term. The clear and straightforward mandate recognises that this is the best contribution that
monetary policy can make to an environment conducive to growth and job creation. This mandate is
not in the least outdated. It reflects the limitations of monetary policy and mirrors the latest insights into
monetary theory and practical experience.
Secondly, the mandate also reflects historical experience. The hyperinflation that occurred in some
European countries, and especially in Germany, in the 1920s left a profound impression on
subsequent generations. In the United States, the Great Depression left its mark and is an important
factor in explaining why the mandate given by the US Congress to the Federal Reserve consists of the
three non-prioritised goals of "maximum employment, stable prices and moderate long-term interest
rates".
Thirdly, the structural differences between continental Europe and the United States, such as the
degree of structural flexibility, impact on the transmission mechanisms and the time lags of monetary
policy. What I have particularly in mind in this context are differences in the transmission that arise
between a more market-based financial system and a more bank-based one, and the fact that
changes in short-term interest rates play a far less important role in investment decisions in continental
Europe than they do in the United States.
Finally, having said that, we have to bear in mind that monetary policy does not have the appropriate
tools to fine-tune the business cycle or to balance deficiencies in other policy areas. At the same time,
not too much emphasis should be placed on monetary policy responses to short-term macroeconomic
developments or even indicators. Activist policies directed at exploiting short-term trade-offs between
prices and economic growth bear the risk of contributing to instability in the medium to longer term.
In the final analysis, all central banks are concerned about price stability. I would not place too much
store on statements that inflation may have been eradicated, even if such assertions do come every
now and then from well-known economists. Such statements put matters too strongly and are rather
heroic in their assumptions. A world in which basic economic relations have ceased to exist is a
dangerous promise to make - perhaps comparable to the irrational exuberance surrounding the hype
of the "New Economy".
Low inflation is an experience of recent history. Its track record does not stretch over decades. And
- as far as the euro area is concerned - the Eurosystem has responsibility for a region with a more
inflation-prone history.
V
Let me summarise the most important lessons.
1. Up to now, monetary policy in the euro area has been successful. Our experience of
anchoring inflation expectations reinforces the commitment to the medium-term approach.
Greater activism would do more harm than good, especially considering the environment of
little structural flexibility.
2. We need to overcome the disappointing weak economic performance in Germany and the
euro area as a whole. Let me be clear about this: the economic problems in continental
Europe cannot be reduced to monetary policy issues. What is needed is structural reform in
member states, including pension reform, health insurance reform and labour market reform.
Fortunately, there is a general recognition of the importance of structural flexibility in terms of
raising long-term growth potential and increasing resilience to economic shocks. Addressing
these issues will rebuild confidence. Even the larger economies are now showing a
willingness to tackle structural impediments.
3. Putting fiscal positions back on a sound track and sticking to the fiscal rules of the SGP
would help to restore confidence. The credibility of consolidation measures is crucial. Fiscal
adjustment should be seen to lead to a permanent increase in future disposable income.
Moreover, if appropriately designed, consolidation can raise output and employment in the
medium term. Positive results will most likely be produced in the short run if consolidation is
combined with structural reforms.
4. The integration of Europe is an ongoing process, which does not always develop as
smoothly as might be hoped for. But, eventually, challenges have been met and the
groundwork for new challenges such as the enlargement of the EU with ten new member
states has been well laid. Nevertheless, all policymakers have to live up to their
responsibilities. EMU offers the opportunity for a more dynamic Europe.