German shift on austerity would risk 'wrong' lessons

Significance

Chancellor Angela Merkel faces a rising tide of euro-area members in favour of a policy shift away from austerity and possibly towards more favourable debt deals for euro-area black spots. Adding to the pressure for change, her own voters may prefer a slower pace of debt reduction: German government debt has already been falling as a percentage of GDP -- from over 80% in 2010 to under 77% at the end of 2014 -- and debt is starting to fall in absolute terms as well. The government has delivered enough stabilisation (ie, austerity) and growth to tame the 2009-10 debt surge and maintain its AAA credit rating, but is now over-achieving in terms of its own tough targets because the greater-than-expected fall in debt interest costs is pushing the budget into surplus. Some modest spending adjustments look likely to curb this windfall surplus, yet many will argue that more could be done to re-energise the sluggish economy -- and boost the euro-area.

Impacts

• The plummeting euro will provoke another rise in German exports (already near 50% of GDP) and tensions over Germany's bulging trade surplus.
• While a fiscal stimulus and/or higher wage payments could address these tensions and raise imports, there is no sign of such action.
• Germany's critics are gathering support to end austerity, to the point of ignoring the risks of deficit financing and reneging on debts.
• Ultra-low German bond yields, encouraged by the prospective supply fall, are dragging down euro-area yields, delivering wider benefits.