Proximate roots of German monetary and fiscal conservatism

This post is all speculation and stereotype, but I think worthwhile passing on as it’s the sort of thing often talked about on the academic conference circuit.  It recaps on a bunch of tweets sent Thursday 18.

The starting point is the observation that the Anglo-American-Latin view that monetary and fiscal policy does best by being strongly counter-cyclical, smoothing out booms and busts.  What Greece needs now, on this view, is sharply expansionary fiscal policy, not a primary surplus, and debt forgiveness [or whatever passes for it] to make that possible.

That view springs most recently from New Keynesian economics, which was invented in the US by the leading academics there.

The influential jobs in German money and finance [Buba/ECB/Finance Ministry] are either staffed by senior German academics, or those that mix with them.  [Like many countries].

German academia is unusually cut-off from American academia.  It’s disporportionately staffed by locals, who trained in Germany.  Partly as a result of this, New Keynesianism and its policy prescriptions did not catch on.  And because of that, German economic policy did not shift with the times either.

There are two significant ideas that did not catch on.  One was the subversion of the old supremacy of money targets as the nominal anchor, and money growth monitoring as the means to achieve them, with inflation targets as the nominal anchor, and attention to interest rate rules as the means to achieve them.

This New Keynesian idea was an anathema to the Buba and ECB Germans that I encountered in my stay in Frankfurt in 2002.  You can see its imprint, rather the lack of it, in the prevalence of the ‘money pillar’ in the old monetary framework of the Issing era, and in the refusal to call the inflation target a ‘target’ (instead it was a ‘clarification’ of an ‘objective’).  And in the ‘close to but below’ wording attached to the 2 per cent figure.  One could speculate too that this was part of the reason for – what some saw at least as – the relatively slow response of the ECB monetary instruments to the onset of the financial crisis.

The second idea that did not catch on was the use of counter-cyclical fiscal policy.  You can see the imprint of that in the Stability and Growth Pact.  And, if you’d sat in on the lunches I had in my ECB secondment, you’d have seen how it infused the thinking of the German economists there.  It also seems clear to me that in the 2010 negotiations over Greece and now, the benefits of pro-cyclical fiscal policy are not appreciated by the German representatives.  Or, if they are, that’s kept quiet as a negotiating tactic.

Most of this, as you can tell, is without much factual basis, except the gossip I listened to on the conference circuit, and my own time on secondment, and casual observation of what has been going on.  So it should be treated more as a hypothesis, rather than a solidly researched point of view.

My tweets did not get that much response on Twitter.  One anonymous follower sent back a series, confirming that German academia was relatively insular;  that appointments favoured locals with long lists of German publications;  and that New Keynesian ideas were frowned upon.   A couple of others concurred, but a couple thought this was either wrong, or a red-herring.

I should point out that there are several great German economists I know working in and outside Germany, and I don’t wish to denigrate any of those.  Mentioning a few inside:  the unsung heroes of Heer and Maussner;  Wolker Weiland.  They absorbed US methods and made them their own, and research in this tradition.  Outside:  too numerous to mention.   But these are exclusively those who were exposed to the US-based frontier thinking, and who subsequently bore the task of pushing back that frontier.

Many might read this and wonder why we should mourn that some policymakers did not absorb New Keynesianism.  For instance, someone should try writing that as a comment on John Cochrane or John Taylor’s blogs, and see what response you get.  ‘So much the better!’ they would say, along with the others who stay within the Real Business Cycle tradition, that thinks business cycles are best left to themselves.

But although I have taken sides on this myself, the point of this post is not to stress that normative point again.  It’s simply a theory that the German negotiating position is partly a product of its isolated academic tradition that left it unnourished/untarnished by modern thinking.

Update:  see the exchanges following Simon-Wren Lewis’ recent post on Mainlymacro, which go into this very subject, the exposure or lack of it of the German economics elite to NK macro.