The roots of the current imbalance, Hill explains, lie in the fact that the financial crisis upset a wrong-for-everyone equilibrium that had allowed a 17-country bloc of very different economies to exist under a one-size-fits-all monetary policy. Before 2008, the European Central Bank’s rates were too low for the periphery and too high for Germany. That led to a massive borrowing and consumption binge in the former and export-led economic growth and low inflation in the latter.
Things reversed course in the periphery as the sovereign debt crisis gathered steam: Nervous investors drove borrowing rates in the periphery much higher than the ECB’s policy rate, forcing an immediate and deep deleveraging. But the reversal wasn’t matched by an equal and opposite reaction in Europe’s core, including Germany. Even near-zero interest rates out of the European Central Bank couldn’t shake German consumers and businesses out of saving their pfennigs.
“The crisis created an asymmetric adjustment and forced peripheral countries to eliminate their trade deficits very quickly through the very deep recession they experienced,” Hill said. “But because financial markets drove this adjustment, and not the ECB, you didn’t get an offsetting change in Germany that would have boosted domestic demand, and therefore, imports.”
When it comes down to it, any debate about Germany’s role in the financial crisis is really a conversation about how much austerity a region can take before the cure becomes another disease. In an October paper entitled “Fiscal Consolidations and Spillovers in the Euro Area Periphery and Core,” European Commission economist Jan in ’t Veld shows that for every euro of either budget cuts or tax increases in a given country, the economy shrinks by an additional €0.50 to €1.