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Economist Paul Krugman Slams German Austerity

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image-101398-galleryV9-dsfy.jpg Nobel prize-winning economist Paul Krugman says that Germany has begun imposing austerity measures far too soon and that it could endanger fragile economic growth. His comments are just the latest in a trans-Atlantic dispute about fiscal policy.

Bank levies and a global transaction tax: those two items will be at the top of German Chancellor Angela Merkel's wish list when she travels to Toronto this weekend for the G-20 summit. With the economy on the slow road to health, so goes her logic, it is time to introduce far-reaching reforms of the global financial system.

With just days to go before the summit starts, however, it is becoming increasingly clear that Merkel may not have much fun during her weekend excursion. Opposition to her reform proposals is widespread and, more ominously, frustration is building with Germany's new focus on budget consolidation and debt reduction.

In an interview with the German business daily Handelsblatt on Monday, Nobel prize-winning economist Paul Krugman joined Berlin's legions of detractors, and took aim at the government's recently agreed to €80 billion austerity package.

"I don't have a problem with trying to balance the budget in five or 10 years," Krugman told the paper. "The question is whether one should start when the economy is at 7 or 8 percent below its normal capacity and interest rates are at zero.... Now is not the time to be worried about deficits." Later in the interview, Krugman said, "the German austerity package is really a bad idea."

Negative Impact

His concern is that German austerity could ultimately have a negative impact on an already fragile US economy and that Berlin is hoping to resuscitate its economy solely through exports. He said that other countries in Europe would suffer as a result of Germany's savings package. "Germany's consolidation policies don't just negatively effect the domestic economy, it also slows growth in other countries," he said.

Krugman is far from alone with his concerns about German and European austerity packages. Last week, US President Barack Obama sent a letter to other G-20 countries in which he fired a not-so-subtle shot across Berlin's bow. "I am concerned about weak private sector demand and continued heavy reliance on exports by some countries with already large external surpluses," he wrote in a clear reference to Germany. He also warned against reversing economic stimulus policies too soon. "We worked exceptionally hard to restore growth," he wrote. "We cannot let it falter or lose strength now."

Germany and France were hoping that the G-20 summit would focus on measures aimed at reforming global financial markets. In particular, Merkel would like to see an international tax on financial transactions as well as a mandatory bank levy, which would go towards a fund to be used to bail out banks in future crises. But opposition to both proposals has been stiff. And the US, in particular, is hoping to use the G-20 to push for more economic stimulus rather than less, given ongoing high unemployment at home.

German Economy Minister Rainer Brüderle countered Obama's comments over the weekend, saying that "Germany can only regain international leadership with a healthy budget." Joachim Pfeiffer, economic policy spokesman of Chancellor Merkel's Christian Democrats, called Obama's comments "economic nonsense."

'Some Fantasy World'

In his comments to Handelsblatt, Krugman was also critical of the European Central Bank (ECB) and of ongoing speculation that Axel Weber, president of the German central bank, will take over from ECB President Jean-Claude Trichet when his eight-year term expires in October 2011. Weber, Krugman said, represents a risk to the European common currency.

"The danger that we could see a domino effect from Greece via Spain and Portugal to Italy is much greater should the ECB end up with such a conservative president (as Weber)," Krugman said. He criticized Weber for being overly focused on inflationary dangers and not worried enough about an extended economic stagnation.

The American economist blasted the European Union for its ongoing attempts to ratchet up the severity of the Stability and Growth Pact in response to ballooning national debt in several countries belonging to the European common currency area.

"The proposals are coming from some fantasy world," Krugman said. "They are going in the wrong direction. A stricter Stability Pact maybe would have saved Greece from almost going bankrupt. But Spain fulfilled all of the pact's criteria and was a fiscal policy star. The changes are aimed at solving a pseudo problem without going after the real roots of the crisis."

Federal Reserve Bank

WALL STREET JOURNAL

U.S. Bureau of Economic Analysis