MATTHEW KLEIN at the FT has a nice post in Alphaville recalling the egregious adjustment in the peripheral euro area current account balances since the Great Financial Crisis (GFC)—from deficit to surplus. Indeed, “the change in the 19-member group’s current account balance can be almost entirely attributed to the crisis countries.” As he points out, similar to the experience of those hit hardest during the Asia Crisis, current account surpluses and deleveraging are forcing global adjustment elsewhere.
While true, of course, this Crisis-reaction narrative somewhat understates the contribution of flawed euro area policies—in an incomplete and disjointed monetary union—forcing adjustment entirely on domestic demand in the periphery, and therefore a compression in imports there, with little offsetting expansion in demand in the Core. This allowed the area-wide surplus to expand at the expense of the rest of the world.
Indeed, the trick for Germany at that time, in order to ride-out lower intra-euro demand, was to switch goods exports towards the rest of the world—China, the UK and US amongst others. This is shown in Figure 1 where Germany’s surplus against non-euro area rest of the world (ROW) expands throughout 2011 and 2012 (measured as percent of EA19 GDP). Meanwhile, the rest of the euro area (ROEA) balance against ROW went from deficit to surplus against ROW, as Klein points out.
Another way of seeing this is witness—and decompose—domestic demand growth in the euro area into contributions from Germany and the remaining countries. This is shown in Figure 2. Germany made a smaller contribution to overall domestic demand through 2007, after which followed a coordinated drop in domestic demand in 2008-09. After a brief recovery, led by Germany, the Crisis hit Europe and domestic demand fall sharply across the euro area once more. But rather than offset peripheral compression, German domestic demand also slowed at this crucial time—meaning there was no counter-cyclical force. Perhaps best seen in terms of the levels of domestic demand in the lower chart, this pro-cyclical intra-union policy reaction was a result of huge mistakes in monetary and fiscal policy at that time.
But this is all backwards looking. What I’d like to celebrate today is how Germany is perhaps contributing—for the first time in over a decade—to global rebalancing. This can be seen in Figure 2 by the fact that German domestic demand growth has contributed more to aggregate euro area domestic demand that the rest of the currency union members put together in the past two quarters. Moreover, the level of German domestic demand has broken the 2 percent trend time for the first time since 2000 (lower chart.)
Furthermore, seen in terms of the 12 month change in euro area aggregate current account balance, which is now compressing, most of the adjustment in the euro area current account is due to Germany. See Figure 3. Indeed, Germany’s contribution to the lower current account over the 12 months through June this year is the largest (in percent of GDP) since 2000 (consistent with domestic demand above). What we cannot be sure of is how much is due mainly to higher oil prices.
But the fact this is coincident with domestic demand picking up in Germany and a global upswing suggests this is more than simply the terms of trade. It’s also worth recalling how many in 2010 and 2011 argued German expansion then would not help peripheral adjustment because this would not directly impact exports there. Well, so what? This missed the fact that by spurring growth outside the euro area would spillback to support the rest of the euro area—exactly as is the case today. A rising tide really does lift all boats.
Yet we have only just begun! It is frightening to hear of Germany’s Council of Economic Experts warning about the risk of overheating. Since 2000, the German share in euro area total GDP has diverged sharply from the share in domestic demand. This gap, shown in Figure 4, is another measure of imbalances in the euro area. With continued domestic demand growth in Germany, in particular offsetting the global challenge of deleveraging in China, and continued current account compression, there is hope that the global recovery will continue. This will allow further peripheral export-led growth, the flipside of the overall rebalancing.
So let’s not cut short the encouraging recovery in German domestic demand. Indeed, fiscal expansion would do very nicely right now. And as Neil Young put it many years ago, perhaps thinking of Germany’s domestic demand expansion within the euro area today: “We’ve been through some things together, with trunks of memories still to come. We found things to do in stormy weather. Long may you run.” [END]