Germany Could Easily Surprise Everyone And Crank Up Deficits To Stimulate Its Economy

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Photo: High Frequency Economics

German GDP declined in the fourth quarter according to most estimates.While there is some speculation that Germany will bounce back as soon as the second half of 2013, High Frequency Economics’ Carl Weinberg isn’t so optimistic given the country’s current path:

“Many people have already started speculating that this economy will right itself as soon as the second half of this year. We do not see any reason for it to do so.”

Why? Tight money and credit, mostly, according to Weinberg. Then there’s slowing exports, thanks to a sagging European economy, tight fiscal policy, slow investment and flat real wages.

However, one way Germany could prevent a downwards economic spiral is to let go of austerity and loosen fiscal policy.

Not only could they afford to, thanks to a deficit that’s well within Euroland norms, this would also be politically palatable.  From Weinberg:

“We believe the biggest surprise for traders and investors this year will be a dash of deficit spending to stimulate demand, initiated in the current quarter to yield fruit by elections next fall. Having achieved substantial austerity and reduced its operating deficit to well within Euroland norms, Germany’s government has the scope to increase its deficit by 1-to-2% of GDP. This would likely improve the sitting government’s reelection chances.”

Of course, if Germany were to loosen fiscal policy, it would really upset its neighbours. After all, they’ve been pushing for higher taxes, trimming public sector spending and cutting entitlements in pretty much every Eurozone country there is.

Beyond that, the only real tangible disadvantage of loosening fiscal policy could be that interest rates for German bonds would likely start trending upwards. But this would probably happen anyway.

“Deficit spending by Berlin would surely steepen the Bund yield curve,” wrote Weinberg.  “This would happen anyway, since Bunds pay zero real yield, which cannot persist in a normal world. Policy will only accelerate the correction of yields to more normal levels.”

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