Posted by: Dirk | January 13, 2009

Germany: ‘Go home, it’s cold’

These were the last words by Peter Struck (SPD) yesterday night, after presenting the fiscal stimulus II in Berlin. The stimulus is disappointing: €50 bn over 2 years. There was no discussion whatsoever about what the stimulus should achieve. So the question of today must be: why €50 bn? What is that to achieve?

As a percentage of 2007 GDP, which was €2422.9 bn, the stimulus is 2 percent (2008 numbers will be available tomorrow). Since it will be spend over 2 years, it is roughly 1 percent. Now how to measure whether this is just right, not enough or too much?

Fiscal spending is done to increase aggregate demand. It is obvious now that there is not enough people buying cars and other stuff, so that some car factories send their workers home for some weeks. Other workers are laid off. Also, products that cannot be sold are sitting in warehouses idle. The idea of a fiscal stimulus is to put these resources to work. This means that in an ideal world, the fiscal stimulus should just close the output gap so that all factors of production are at work again.

Now, estimating the output gap can be done by using statistics or by doing a back of the envelope guesstimate. I prefer the latter, since I don’t have too much time. It is said that according to Okun’s law, an extra point of unemployment can be erased by a 2 percent rise in GDP. Fiscal spending triggers an effect that is enhanced by the Keynesian multiplier: fiscal spending increases income of workers and firms, which spend that money on something, which in turn triggers more economic activity, and so on. The strength of the multiplier depends on taxes and other institutional arrangements. It is relatively low in Germany because of its automatic stabilisers (progressive taxes, unemployment benefits, mandatory health care).

Right now, unemployment in Germany is 7.4 percent, which is pretty low given that the last years were worse. However, the prediction of growth for 2009 is in the range of 0 and -3 percent, which would imply that unemployment rises by up to 1.5 percent. I think given what happened in the world, mainly that demand falls on a global scale and German exports have been shrinking by more than 10 percent over a year recently, one should not be optimistic. So let’s use a -2 percent growth rate for 2009, which translates into an two extra points of unemployment.* Even though the German economy has better automatic stabilizers than the US, I would still think that my scenario is more optimistic than reality.

To erase this extra two points of unemployment, the stimulus has to reach two four percent of GDP. Above we have noticed that it reaches only one percent. The output gap cannot be closed by the stimulus then. Some extra unemployment will exist, and this is the direct result of economic policy. (A hard sell in an election year, I suppose.) Let’s hope for the best.

* I made a mistake: -2 percent growth means two points of unemployment, since a growth rate of two percent is required just to stablize unemployment.

UPDATE 15/01/2009: I have implicitly taken the recent unemployment rate of around 7 percent as the equilibrium rate of unemployment consistent with full employment. This is probably too pessimistic – therefore, my scenario might be understate the size of the fiscal stimulus. On the other hand, fiscal policy of other countries might increase economic activity. But the outlook of this is rather dim. That means that the Konjunkturprogramm II should have been even bigger. I will write something later about the consequences of a possible failure.

Advertisements

Responses

  1. […] do exist, see my old post). Also, my comment on the second stimulus looks pretty good by now. In January I argued that the stimulus should have been 4% of GDP instead of 1% on the basis that the employment outlook […]

  2. […] I wrote the paragraph above in mid-January 2009 after the announcement of the German stimulus. Now the discussion about the consequences of saving banks but failing to adequately save jobs become apparent. Unions have warned of social unrest, and in reply chancellor Angela Merkel has called for muting all talk about social unrest, according to Der Spiegel. According to the government, the economy will rebound by mid-summer and show positive growth in 2010. This, as an economist, I can hardly believe. […]


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Categories

%d bloggers like this: