Posted by: Dirk | December 12, 2014

German government balances budget while earning profit on its debt

The German government had announced that it would balance a budget and get a black zero, and it seems like it is sticking to its strategy. The employers are celebrating this, with their Institut der deutschen Wirtschaft writing:

Of course, economically there is no reason to reach exactly zero financial deficit. Black Zero is not a theoretical concept but a number, a symbolic figure. Nevertheless, this figure represents the reliability of fiscal policy in Germany. It goes one step further than the debt brake rules which even allow for ‘cyclical breathing’. This means that while a cyclical deficit is within the rules during an economic downturn, the debt needs to be paid back as soon as the economy recovers.

The idea of fiscal reliability is what is the difference here between the employers association and serious economists. As a serious economist, one would have to point out that fiscal policy is an instrument of economic policy. Our textbooks tell us – and this means economists do all agree – that in case of weak demand the government should not let the market do its magic, but instead should use economic policy to move the economy towards full employment. (You surely recognized the IS/LM model by now.)

So, the government can choose between monetary and fiscal policy. Since in the euro zone monetary policy is already at the zero lower bound, with interest rates basically at zero, fiscal policy is the only option left on the table. We have a little bit below record unemployment in the euro zone, and the reason is quite obvious weakness of demand. People would like to buy more, but they don’t have enough money. If government would spend more, then people would have more money and could demand more stuff. Alternatively, it could lower the tax rates. This should be beneficial for enterprise.

So, oddly enough the German business association is happy with not selling more. It is strange to see them arguing for less government spending, especially since this German government is absolutely not interested in increasing the public sector and probably would spend it all on buying goods and services from private sector firms. If we had full employment I could see there point, even though more inflation usually is good for businesses that are net debtors, but we are not even close.

Now, with the latest developments on the sovereign bond market this whole exercise gets a whole new twist: in the last bond auction of the Finanzagentur (finance agency) two-year sovereign securities were sold with a 0% coupon, meaning that the interest rate on this debt is zero. That, however, was not enough. The bonds sold above par, so that investors paid more than €100 to get €100 from the German government two years hence. The German government is actually making money by issuing debt! It does not have to pay interest, it receives interest on its liabilities!

If by now you wonder what is riding politicians and employers to enforce a balanced budget in times of economic distress I would say that they have fallen prey to plain wrong economic theory.


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