In praise of German conservatism

Europe has been used to Germany providing a strong monetary anchor since the collapse of Bretton Woods, but Europe should also value the strength of the German fiscal anchor. By running a balanced budget at the peak of the economic cycle in 2007 (sustained also into 2008), Germany was well equipped to lay its fiscal credibility on the line when doing so became essential for the future cohesion of monetary union. At a time of crisis for Europe, it is indeed fortunate that the German budget deficit ratio to GDP this year is likely to be a relatively moderate 4% (or thereabouts).

Advocates of fiscal activism have been served a sharp reminder by bond market vigilantes that there is no such thing as a free lunch. As with quantitative easing by central banks, fiscal activism is a useful tool to have, but works only if the institutional framework is sufficiently credible. This is why it is now so important for the G20 members to demonstrate fiscal solvency – for they are the ultimate “back‐stop” of confidence. Europe in particular must find new ways of demonstrating fiscal competence, given the failure to adhere to the existing rulebook.

In this context, the G20 offers an ideal forum for mutual understanding and learning, especially since most of its “non‐G7” members have emerged with significantly stronger fiscal positions, and also in many cases are now substantial sources of financing. The recent decision by China to adopt a more flexible exchange rate sends an important signal of both confidence and cooperation for the future.

The next few years will see profound changes in fiscal, regulatory and structural policies. The G20 provides the correct forum for all policymakers to evaluate the interaction of these factors, which is likely to be complex. In turn, while monetary policy has a leading role to play in sustaining confidence, it will also be vital for central banks to adopt flexible, nimble and pragmatic policies, particularly in terms of evaluating and therefore seeking to anticipate the implications of these changes, including potential changes in monetary policy.

In short, steering the G20 economies into a path of sustainable growth, to bring down exceptionally high unemployment in the US and Europe, will be a major challenges and will require a particularly high level of alertness on the part of all governments and central banks.