03 December 2013

The German 'Grand Coalition' - Commentary review

The Grand Coalition has been called a success (on domestic issues) by trade unions, and "unintentionally positive" by others. Its stance on Banking Union appears to be "more of the same", but the fact that Germany no longer seems to be insisting on treaty change is seen as a minor breakthrough.

Philine Schuseil writes for Bruegel that German trade unions consider the coalition treaty to be a success, in particular the introduction of a minimum wage, the early retirement age of 63 years and the introduction of rent controls. However, the treaty is very controversial in the German business world and among economists. According to Deutsche Bank research (subscription required), "the treaty reflects the need to compromise instead of providing an ambitious agenda for Germany to address the upcoming economic and political challenges. The agreement reverses some of the previous successful reforms in the labour market and the social security system via give-aways in the pension system and by introducing a nation-wide minimum wage."

The coalition treaty foresees excess expenditures of €23 billion over the next four years. "It is difficult to justify the new social spending plans of the treaty with the background of inter-generation fairness", says BdB (Association of German Banks) president Jürgen Fitschen. Comments in the media focus largely on domestic rather than EU policies. The treaty stresses Germany’s responsibility in EU politics and the government’s position on Banking Union is not very different from its previous one. However, legal hurdles are mentioned as well as the need to change the German law in order to allow for a direct re-capitalisation of banks via the ESM. Moreover, economic coordination and budget supervision should be strengthened further, bilateral reform contracts should be considered as an instrument to foster structural reforms, and the parties agreed to push for the introduction of an EU-wide financial transaction tax.

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The Economist's Charlemagne comments that without humour, as became abundantly clear, these talks would have failed many times over. There were blow-ups in committees. The Social Democrats irritated the CDU and CSU by referring the coalition agreement to a referendum of the SPD's 470,000 party members (those votes to be counted on December 14th and 15th). Then they irritated them even more by declaring the SPD open to future coalitions with The Left, a party that descends from East Germany's communists. But if the three party leaders' chemistry on the day of the press conference presenting the agreement was any guide, this coalition might just succeed after all.

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On a more serious note, Wolfgang Münchau, writing for the Financial Times (subscription required), warned that the coalition would have to break promises and the political class would be tested by what the eurozone will throw at it. No matter which crisis resolution scenario prevails, some promises made to the electorate are going to be broken.

In the next four years, Greece will either default or exit the euro – or both. The EU’s "pretend-and-extend" strategy of revolving loans at longer maturities and lower interest rates is approaching a natural limit. And what German politicians generally do not realise is that their stance on a proposed eurozone Banking Union contributes to the credit crunch and its persistence. The ECB, meanwhile, is close to exhausting its conventional monetary policies. It can fiddle around the edges with a funding-for-lending scheme, more long-term liquidity operations, or maybe another tiny rate cut. But this will hardly be enough to counter the deflationary pressure from the credit crunch, and the adjustment of prices and wages in the south with no offsetting adjustment in the north. 

The ECB does have an alternative course of action. It could buy up large chunks of eurozone debt. This should not be confused with the outright monetary transactions – a conditional emergency backstop for sovereign debtors that may never be triggered. The ECB could supplement that programme with one of credit easing, or quantitative easing, to bring down long-term interest rates. The big political question is how well Germany’s political class, and its constitutional court, would adjust to this type of crisis resolution. It would not be consistent with the current political or legal consensus.

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Writing for Social Europe Journal, Andrew Watt says that the German Coalition Agreement has unintended consequences for Europe. Judging only by the sections that explicitly deal with European issues, the short answer to what Europe can hope from this agreement is "nothing good". Fortunately a number of measures motivated purely by domestic concerns will have favourable knock-on effects on the rest of Europe. Overall, then, the impact ought to be a small positive.

The policies envisaged will help ensure that Europe will remain enfeebled and Germany’s "responsibility" for Europe limited. Behind the pious language, the nine pages can be summarised as saying that the previous and future Chancellor Merkel and her Finance Minister Schäuble will continue to hold the reins of German policy on Europe firmly in their hands. Symptomatic of the approach in this part of the agreement is that a few costless bones are thrown to the social democrats: the consolidation must be accompanied by “socially balanced investments in growth and employment”, without anywhere setting out clear commitments to, or mechanisms for, such additional investment. There is also a strict denial of the need for any form of debt-pooling, an insistence that European financial support is an ultima ratio, that requires strict conditionality and parliamentary (i.e. Bundestag) approval. 

Thus it is fortunate that, ironically, when the two parties are not actually thinking about Europe, but about domestic issues, they promise policies that will actually benefit the continent as a whole. By far the most important of these commitments is the introduction of a statutory minimum wage of €8.50 per hour across the whole country from the start of 2015. Other things equal, the resulting stronger wage and price dynamic will tend to push down the external value of the euro, which again will ease the squeeze on producers in other EMU countries without going through bilateral trade balances. And fiscal policy is likely to be somewhat supportive of aggregate demand in Germany, once again with (limited) beneficial effects in other countries.

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Julian Priestly, writing for Policy Network, argues that the German coalition agreement is important for Europe. It marks the first stage in a rebalancing of the European economy, and a greater flexibility on the key questions of governance of the euro. 

The agreement is a compromise but marks a departure in European policy which the European left should note carefully. Nationally, having for the first time a minimum wage and a socially progressive pension reform is important; for Europe it marks the first stage in a rebalancing of the European economy. On Banking Union, the outcome is more balanced. Yes, the Bundestag will have to vote on each recourse to the ESM; and the European deposit guarantee scheme has been rejected. On the other hand the deadlock has been broken; the new government will not insist on treaty change as the price to pay for Banking Union. Direct recapitalisation of banks is accepted as a last resort. And the end of the blockage on a European resolution fund is crucial, as is the endorsement of a common fund financed by the industry. Germany seems now to accept that the way forward for Europe is through a compromise between responsible public spending, economic growth and incentives for investment.

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Jacob Funk Kirkegaard for Peterson Institute argues that despite the concessions made by Chancellor Angela Merkel to the also-ran parties in the German election last month, the new governing Grand Coalition strengthens her dominance of German and European politics for several reasons.

On Banking Union, Germany favours a full imposition of costs on creditors in troubled banks along with a speedy and effective Single Resolution Mechanism (SRM) for their dissolution. The Germans also seek to respect the budgetary sovereignty of the Member States when it comes to using taxpayer funds to help banks. As the German finance minister Wolfgang Schäuble has insisted, the power to dissolve banks is to rest with Member States and not the European Commission. The agreement clearly envisions a direct bank recapitalisation of banks as potentially part of the upcoming bank stress test exercise. Only if such private solutions are not possible are the public backstops to be required—something that will be discovered after the stress tests and after the ECB begins its supervisory function in November 2014.

The guidelines for direct bank recapitalisation from the ESM are not without risks. Banks can lose the confidence of markets very quickly, after all, and governments are generally unwilling to accept "appropriate conditionality" in the absence of financial market pressure. The coalition agreement therefore sets up a plan for handling holes in the euro area bank balance sheets (and sovereign finances) that could be visible in 2014. 

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Robert Leicht, writing for the Zeit, argues that the grand coalition can only be financed if the economy is growing. Failing that, the calculations for the state treasury no longer add up. However, a whole series of measures proposed by the upcoming grand coalition will slow down the growth of the economy in the medium term. 

Were interest rates on government debt to rise only by one percentage point, were the economy to perform just a little short of expectations, were it to come to another small crisis or were Germany to engage seriously in European solidarity, the calculations would become inconsistent as they were based on a best-case-scenario.