Germany is "balanced", it's the rest of Europe (and the ECB) that are unbalanced
By Scott Sumner
In economic theory, there is no particular reason why countries should have “balanced” current accounts. No one cares that California’s current account with the rest of the US is usually unbalanced, and often by a sizable amount. Nor should they care. Perhaps the most basic misconception is when people try to draw causal inferences from this identity:
GDP = C + I + G + (Ex – Im)
It looks like a current account surplus would boost GDP. However the current account surplus is exactly equal to (S – I), and that net foreign investment term has an equal and opposite impact on GDP. Never draw causal inferences from an identity.
People like Paul Krugman make more sophisticated arguments. They admit that in normal times current account surpluses are not a problem, but insist that everything is different at the zero bound, when there is a global demand shortfall. Ben Bernanke seems to share this view, suggesting that the world would be better off if the Germans reduced their current account surplus with a more expansionary fiscal policy and/or higher wages.
I think that’s a bad idea. Instead of criticizing the German fiscal and labor market policies, we should be criticizing their views on monetary policy and emulating their excellent policies in other areas.
Bernanke is a bit vague as to the ultimate cause of the demand deficiency that he refers to, but in the case of Europe there really can’t be any doubt—the ECB. And before anyone brings up the “zero bound” issue, recall that the eurozone has been at the zero bound for only a small percentage of the past 7 years, and indeed the ECB was raising interest rates as recently as 2011. It was tight money that caused the demand deficiency.
The ECB was a really bad idea, as the Greeks and the Germans do not belong to the same optimal currency zone. If there had to be an ECB, then running an ultra-tight monetary policy in the midst of a deep recession and massive debt crisis was a mistake of almost mind-boggling proportions (as Bernanke surely recognizes but is too polite to mention.)
But if you insist on having a euro, and then insist on having an absurdly tight monetary policy that drives NGDP lower, then the only real solution is to align your wage level to the reality of low NGDP. The Germans have done that; they’ve “balanced” their economy. The others have not.
It’s interesting that Bernanke’s post provides a graph of the Germany CA surpluses, which somewhat undercuts his argument.
The surplus was in the 4% to 6% of GDP range throughout the 2002-07 period. And yet “despite” that huge surplus, Germany suffered from double-digit unemployment. The Germans fixed the problem the only way they could (given the euro) they reduced labor costs and provided low wage subsidies to get people off welfare. Unemployment fell to 4.8%. Other European countries should have done the same, but most are too left wing to do so. So they must suffer, the Greeks most of all.
There may be worse policies than right wing monetary policy combined with left wing labor market policies, but I can’t really think of any.
At this point people often make the silly argument that not all countries can run current account surpluses. Yes, but as we can see from the German case, current account surpluses have nothing to do with unemployment. All countries certainly can cut their wages to fit the lower NGDP, or much more sensibly all countries can agree to give the ECB a better mandate, such as NGDPLT, and boost NGDP to fit the wage level of the overall eurozone. (Of course many individual countries like Greece would still need major structural reforms.)
The key to success is monetary policy that stabilizes the path of NGDP (i.e. level targeting), flexible labor markets, and pro-saving fiscal policies. Always. Even at the zero bound.
Update: The US experienced a current account deficit of $410 billion in 2014. The eurozone experienced a current account surplus of 240 billion euros in 2014. Guess which region has an unemployment rate double the other region?