Last December I have discussed on this blog why the DIW (German Institute for Economic Research in Berlin) declines to make any more forecasts on economic growth in Germany. Klaus Zimmermann, the head of the DIW, explained that he had no models for financial crisis. Therefore, he would not make any more predictions. Yesterday he broke this promise. Zimmermann expects the economy to hit rock bottom this summer, although the growth rate for the whole year will still be minus 5 percent. To his credit, no prediction for 2010 was offered.
Nevertheless, both predictions are a complete black box. Why should the economy recover? Where will the demand be coming from? These questions are not answered. Instead, a recovery of financial markets is hoped for. But that fixes only one problem of the situation we are in: banks are not lending, firms are not investing. The latter depends on demand and finds no mention in the DIW report.
Also, the DIW recommends less fiscal stimulus and the creation of a bad bank. In the earlier post from today I recommend Willem Buiter’s post on finance. He thinks that what we need now are good banks, and not bad banks. The banks are so deep into trouble that saving them would continue for years probably and would take so much tax payers money that in the end the whole solution will be impossible to do. I agree with Buiter on this issue.
My opinion on (no) more fiscal stimuli I have already expressed in the comment on the DIW being helpless without models for financial crises (which 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 was bleak with export demand falling. In hindsight even 4% seem to be too small of a stimulus, since that would probably not have pushed the growth above zero (given that with the 1% stimulus we had the predicted growth rate is still -5%!).
I strongly believe that the writing is on the wall now: we are in the middle of a Great Depression-style debt-deflation. The Great Depression showed the following signs that something was wrong: 1) stock market crash 2) loss of monetary policy as a tool 3) failures in the banking system 4) falling demand, causing mass unemployment, and 5) a hefty decrease in world trade. The theory that afterwards delivered the explanation was Keynes General Theory. It has a financial crisis as the root of the problem. Does anyone in DIW know this?
I respect the opinion of the DIW, but what applies to banks should apply to institutes of economic research as well: you should conduct your business in the open and not base your outlook of the future on wishful thinking derived from some black box. Also, if you turn out to be incompetent you should pack up and leave.