False economies The sweet poison of low interest rates

The euro zone has saved well over €1 trillion in interest payments over the last decade, but governments have failed to use the windfall to get their budgets in order.
Quelle: Imago
A different kind of capital flight.
(Source: Imago)

Euro member states have saved a staggering €1.42 trillion ($1.63 trillion) in debt service payments since 2008 as a result of interest-rate cuts to defuse the debt crisis, according to Bundesbank calculations seen by Handelsblatt.

The German government alone has spent €368 billion less on interest over the last decade than if rates had been at normal levels. France has saved €350 billion, while Italy forked out €261 billion less – amounting to 15 percent of Rome’s GDP.

The European Central Bank saved the euro by shifting rates to rock-bottom levels and buying up trillions of euros’ worth of government bonds. This meant that in 2018, Germany ended up paying investors a yield of just 1.5 percent on its sovereign debt, down from 4.2 percent in 2007.

The policy was deeply controversial in Germany, where private savers lost a net €300 billion between 2010 and 2018, according to DZ Bank research. But it’s also enabled Berlin to achieve what in ordinary times would have been unthinkable: It’s hiked spending on welfare and defense while cutting taxes and reducing its public debt.

The bomb is ticking

That kind of fair weather fiscal policy only works when interest rates are this low. Once credit tightens, the government will have to start plugging budget holes once more.

But at least Germany, thanks to its ongoing budget surpluses, has fiscal leeway. Other euro states have wasted the windfall by failing to cut their shortfalls, prompting warnings from economists that history might repeat itself.

After the euro’s launch in 1999, many member states enjoyed a dramatic drop in interest rates and responded by hiking their borrowing. When the 2008/2009 financial crisis sparked a sharp rise in rates, they ran into trouble servicing all that debt. Enter the euro crisis.

Now, a number of countries are similarly vulnerable to rising rates, blissfully unaware of the interest-rate bomb ticking in their budgets.

Seeking soft options

Greek Prime Minister Alexis Tsipras has just reversed labor reforms that the EU had demanded of him in return for the last bailout. He has canceled planned pension cuts and paid out €700 million in a “social dividend” to 1.4 million families. Critics say Greece, which exited eight years of bailouts in 2018 and returned to borrowing from the market, is already slipping into its next crisis.

France looks set to exceed the EU’s 3 percent deficit limit this year after President Emmanuel Macron made expensive fiscal concessions to the yellow vests movement. And Italy’s budget, agreed only recently after months of fractious negotiations with the EU, remains a worry as the economy teeters on the brink of a recession.

“More government debt seems like an easy way out and allows short-sighted politicians to hand out gifts and survive the next election,” said the head of the Ifo economic institute, Clemens Fuest. “That’s precisely what led us to the situation we’re in today.”

The ECB’s policy was aimed at helping countries like France and Italy that have battled sluggish economic growth and high deficits. But both are still falling foul of the deficit rules.

EU penalties unlikely

“Italy and France are still increasing their structural budget deficits and are poorly equipped for cyclical downturns,” warned Markus Ferber, a member of the European Parliament for Angela Merkel’s Christian Social Union.

But neither is likely to face deficit procedures in the foreseeable future. With the European Parliament elections looming in May, the EU Commission seems at pains to avoid further conflict that would give Rome’s populist government ammunition in the campaign – and to take no action that could weaken the embattled, pro-European Macron.

Tsipras, meanwhile, is no longer the pariah he once was in Merkel’s eyes. She sees him as a pragmatist, not least because of the deal he negotiated in the decades-old name dispute with Macedonia which the West hopes will open the country’s door to NATO and the EU and thereby help stabilize the Balkans.

That explains why the woman Tsipras once referred to as “the most dangerous politician in Europe” will likely only briefly address the reform reversals during her visit to Athens on Thursday.

Expect smiles and handshakes and no repeat of the burning Merkel effigies witnessed on the streets of the Greek capital at the height of the euro crisis.


Martin Greive is a correspondent for Handelsblatt in Berlin. Till Hoppe reports from Brussels, while Gerd Höhler is based in Athens. David Crossland adapted this article into English for Handelsblatt Today. To contact the authors: [email protected], [email protected], [email protected]