How the Greek crisis helped Germany

A few days ago Tyler Cowen did a post discussing the 8.8% RGDP growth rate in Germany in the 2nd quarter.  Because I had previously expressed skepticism about the robustness of the Germany recovery, let me congratulate Tyler for being correct.  Nevertheless, in my never-ending struggle to turn sow’s ears into silk purses, I tried to make the best of it with this essay over at The Economist.  Yes, I was wrong about the recovery (which I still think was less than robust until the second quarter) but the blowout number for German growth shows I was right about something far more important.  I know what you are thinking, “How convenient, he can make up ad hoc theories for his past mistakes.”  Bear with me; this is what I said in May:

“So stocks in the heart of the eurozone, the area with many banks that are highly exposed to Greek and Spanish debts, are actually down a bit less (on average) than the US.  Perhaps the strong dollar is part of the reason.  Perhaps monetary policy has become tighter in the US than Europe.”

Now I certainly did not expect 8.8% growth in Germany, but I did point out that the Greek crisis might have been hurting the US more than Germany.  Recall that it sharply appreciated the US dollar against the euro, and that those gains were closely linked to news stories about the Greek crisis.  So I think it is reasonable to infer that worries about the “PIIGS” led to an increased demand for dollars, which caused the dollar to appreciate.  In principle, the Fed could have prevented this by increasing the supply of dollars, but they are reluctant to do unconventional QE.

I’d also like to mention a few ideas not in The Economist essay.  Let’s start with the slowdown in US growth.  David Beckworth has a post that shows May and June were the key months, when growth in US NGDP began to slow sharply.  But can we really link this to tighter money?  After all, doesn’t monetary policy work with long and variable lags?”   Actually no.

Monetary policy affects the economy almost immediately.  It is very hard to identify monetary shocks with postwar data, because policy is so endogenous.  But in the interwar period there were some large monetary shocks that were easily identifiable, and in each case they led almost immediately to a sharply change in:

1.  Stock prices

2.  Commodity prices

3.  The WPI

4.  Industrial production

Those who want to argue long and variable lags have a problem.  It isn’t just the empirical evidence I cite, on theoretical grounds the impact on stock and commodity prices must be immediate (unless there are a lot of $100 bills lying around on the ground.)  But the movement in stocks and commodities is closely correlated with broader price indices and monthly industrial production.  So whatever caused the prices of assets to change was also probably driving industrial production.

And of course we see the same thing in modern times.  The great fall in industrial production in late 2008 occurred at the same time stock and commodity prices were collapsing.  We know the Greek crisis sharply depressed US stock and commodity prices in May 2010.  Now that we get the GDP report, we also know that it depressed NGDP, especially in May and June.  In Germany, the effect was positive, as the weaker euro gave a big boost to the already robust German export machine, which is a big part of the German economy.

So what can we learn from all this?  Here are some lessons:

1.  Krugman was wrong in suggesting that the slowdown this spring was entirely predictable from the planned phase-out of stimulus.  The slowdown was associated with a sharp drop in stock prices, which was obviously unforecastable.

2.  Krugman was wrong for another reason; the slowdown in the US was not due to less spending, but rather less output growth, as the trade deficit worsened dramatically.  And German output soared with strong exports.

3.  There are no long and variable lags, the economy responds almost immediately to monetary shocks.

4.  Monetary shocks (changes in the supply and demand for dollars) are often much more important than real shocks (banking problems.)  The Greek crisis put the German and French banks under a great deal of stress.  Yet the German economy grew fast, as the weaker euro was like an easing of monetary policy.

5.  I do share one trait with Krugman.  We both have an almost shameless ability to turn failed predictions into claims of “See, I was right all along!”

[Krugman fans:  Just kidding, he actually does have a pretty good track record at forecasting. But he can be a bit hard to pin down at times.]

Next post:  long and variable LEADS.

Rashomon in Deutschland

Before starting today’s post, a few quick comments:

1.  I am quoted in  Considering that it is necessary to water things down a bit for the general audience, I thought it was actually pretty good.  I said in the interview that 3% inflation for 2 years followed by 2% inflation was about right.  But what he wrote is close enough.  And he got the tricky negative interest on reserve thing exactly right–so I can’t complain.

2.  Those readers thinking “I wish someone would take that arrogant Sumner down a peg or two” should be reading the comment sections of recent posts.  Andy Harless, who is a distinguished monetary blogger, has been giving me some very tough questions.  He has skillfully exposed some of the soft underbelly of my arguments, especially in the “Power Seduces” comment section.  I will add him to my blogroll.  He is very smart.

Here are 4 very different views of Germany:

Paul Krugman:  Germany is an anti-Keynesian villain.

Tyler Cowen:  Germany is an anti-Keynesian success story.

Der Spiegel (from Mark Thoma):  Germany is a Keynesian success story.

Me:   Germany?  Successful?

I do understand that Germany has done very well on the jobs front, and deserves credit for that.  But I don’t see that as a Keynesian success.  Keynesian stimulus is supposed to create jobs by boosting NGDP, and NGDP has done much worse in Germany than the US (as has RGDP.)  Their jobs success comes from reduced hours, not more output.  Output is still well below 2008 levels, and is expected to remain lower for years.

Germany’s strength, in my view, is its manufactured goods export sector.  I don’t know why they are so good at building BMWs and turbines, but my hunch is that it isn’t fiscal stimulus.  It probably has more to do with an educational system that has a technical skills track, and which doesn’t bore normal boys out of their minds in a futile attempt to use schools to create an egalitarian society.

This reminds me of a point made by Tyler Cowen last month:

I’m a fan of the northern European social democracies, but in part they succeed because those countries don’t follow all of the prescriptions you might hear coming from their boosters in the United States.

PS.  This New York Times article suggests that German technical education was already superior to ours by 1902.

What’s wrong with Europe?

During 1990 I travelled all over Germany, and was impressed by its urban areas.  For some reason I expected cities in the industrial heartland such as Dusseldorf and Cologne to have a grimy appearance.  Instead they were very attractive and convenient.  So I see why people are impressed with Germany.  Even so, I was perplexed by this Tyler Cowen post, which suggested the German economy was doing well.

The [German] economy is continuing to grow, unemployment has been falling for twelve months, and the long-term fiscal picture is improving.  Plenty of vacations are being postponed.  You don’t have to think that real shocks caused the downturn to believe that real factors provide the way out.  The full story is here.

Beggar thy neighbor?  Don’t blame the productive.  Besides, a lot of what the Germans are producing and selling is inputs for other people’s production:

“Ulrich Reifenhäuser, managing director and owner of plastics machinery maker Reifenhäuser, said his company was struggling to cope with an order increase of more than 100 per cent in some months this year.”

You may recall that Alex — a prophet of the MarginalRevolution — has long predicted Germany as an economically undervalued country.  Now that events have caught up with him, he needs a new pick…

I agree that people shouldn’t be bashing German fiscal policy (although they should be bashing German (aka ECB) monetary policy.)  But in what sense is Germany doing well?  I looked for the most recent RGDP figures I could find, including estimates for 2010 and 2011, and found this useful IMF link.  As you can see from Table 1, Germany had a far more severe recession that the US, and is having a far slower recovery.  Indeed the same is true of the entire eurozone.  Between 2008 and 2011, the IMF expects 3.8% growth in the US, and negative 1.8% growth in the eurozone.  Even accounting for the difference in population growth rates, that’s roughly 4% higher RGDP growth in the US between 2008 and 2011.

When the crisis hit in 2007-08 we were told that it was all caused by deregulation implemented by the evil Republicans, and that this was why Europe was doing better.  Indeed RGDP growth in 2008 was a tiny bit higher in the eurozone than in the US.  But wasn’t the implication of that explanation that Europe should do better than the US over the next few years?  Even if they got hit by spillover from the US subprime/banking crisis, you’d still have expected them to have a milder recession than we had, wouldn’t you?  Of course there is one area where they have done better; unemployment has risen much less sharply than in the US, as their governments use various techniques to discourage layoffs.  And that’s a good thing.  But it still doesn’t explain why output has done so poorly in the eurozone.

Don’t think I am saying “I told you so;” I did not predict this, nor do I have any explanation.  A few weeks back I did a post arguing that the European countries had stopped gaining on the US after 1980.  My default model is that once countries are fully developed, they should all grow at about the same rate.  Those with less efficient (i.e. less neoliberal) models should plateau at a level slightly below the most efficient countries (US, Switzerland, Singapore, etc.)  But at that point they should grow at about the same rate, as long as their model doesn’t get even less efficient relative to the US economic model.  And it doesn’t look like Europe’s model has regressed relative to the US.  Indeed, if anything it has been the US that has been regressing in recent years (even before the Obama election.)  It is the US that has slipping in the Heritage Foundation Economic Freedom rankings.  So I am just as puzzled as anyone else by the fact that the eurozone, which was already about 20% to 30% behind the US using the 2008 data in my earlier post, now seems set to slip another 4% further behind the US in per capita GDP.  And even a relatively efficient eurozone country such as Germany, which avoided the real estate bubble and benefits hugely from a complementary relationship vis-a-vis China, seems set to slip even further behind the US.

Does anyone know what I am missing?  I suppose it might have been monetary policy, but the euro has been considerably weaker than the $1.60 levels it hit prior to the crisis.  So I am genuinely perplexed by the European situation.  I’m not a huge fan of their high tax model, but I don’t see how it explains this sort of dismal economic performance.