Economic Weekly Ages, Wages and Prices

Germany's Bundesbank doesn't think an ageing population will lead to falling wages. The ECB doesn't think it needs to worry about German inflation. Our chief economist reviews the week.
Jens Weidmann and Mario Draghi had plenty to say this week. Not that they agreed on much.

Recession proof

Some economic historians like Moritz Schularick, who does research at the University of Bonn, believe a recession is overdue in Germany after an almost 10-year economic recovery. However, there is no sign of one on the horizon. The Ifo Business Climate Index, the most important German economic indicator, rose in April to 112.3 points, the highest level in almost six years. This jubilant mood among the roughly 7,000 corporate leaders polled was not based solely on their outstanding assessment of the current situation, but also on a strong outlook for the coming year. Nevertheless, the economic historians will undoubtedly be proved right at some point in the future: Even a broken clock gives the right time twice a day.

No free money

Germany’s central bank, the Bundesbank, had two special studies in its monthly report for April published this week. One addressed the concept of "positive money," an idea supported by former Deutsche Bank chief economist Thomas Mayer, which essentially says commercial banks should maintain 100 percent of their deposits in reserve with central banks. This would deprive commercial banks of the possibility of creating their own money and lending beyond their means; central banks would become the uncontested rulers of macroeconomic credit volume, and credit-driven boom-and-bust cycles would no longer exist. The Bundesbank’s surprisingly short analysis of this idea, first developed by Irving Fisher at the outset of the 1929 Great Depression, doesn’t go beyond a rather soft plea that strengthening the financial system "should take place in different ways, from the current perspective." There have certainly been more forceful analyses by the economic department of this central bank in the past.

Aging Germany

The same monthly report also analyzed – once again – the effects of Germany's aging population on economic growth. The outcome of this traditionally-structured analysis is clear: Germany’s potential growth is declining as a consequence of aging, even if this does not necessarily apply to the wages of individual workers. What’s surprising is that the analysis makes no mention of a study by American economists Acemoglu and Restrepo that caused a stir back in 2016. In an international comparison, these two economists arrived at virtually the opposite result: Aging societies consistently produce in more capital-intensive ways, utilizing the possibilities of automation to replace workers, but there is no evidence that population aging impairs economic growth.

Spring is here

The German government unveiled its spring growth forecast on Wednesday, the second of three government forecasts issued each year. As expected the spring forecasts – which will also serve as the basis for the finance ministry’s tax forecasts this year – point to the very strong state of the German economy. The economics ministry, the lead government agency behind the forecast, writes that the geopolitical environment, which is characterized by growing risks, has not impeded the solid course of economic growth to date. This is why the German government expects to see a 1.5-percent increase in economic output this year, as well as 1.6 percent growth in 2018, together with record employment of 44.4 million people. Because exports will develop somewhat more weakly than imports, the report reads, the contribution to growth from foreign trade is slightly negative once again, despite the country’s near-record surplus. The drivers of growth are strong construction investment and private consumption, which is supported by rising employment and strong increases in wages and pensions. Rarely have the prognoses of private economic institutes and the federal government been as much in agreement as they are this year.

Trade rebound

Apropos the negative contributions to growth from foreign trade: The real volume of world trade stagnated in 2015 and 2016. Yet first-quarter data released this week show that this globalization pause may have been overcome, as world trade had noticeably picked up speed again. As a result, German exports could increase significantly, and positive contributions to German growth could soon come from foreign trade again. In that case, criticism of Germany's export surpluses will likely become even more acrimonious. Finance Minister Wolfgang Schäuble, Economics Minister Brigitte Zypries and Bundesbank President Jens Weidmann, who represented Germany at the spring conference of the International Monetary Fund (IMF) last week, may have a thing or two to say about that.

Trump’s 100-day legacy

The first, disastrous 100 days of Donald Trump's presidency will end this Saturday. To avoid looking completely empty-handed, he had Treasury Secretary Steven Mnuchin announce the "biggest tax reform in US history" on Wednesday evening. Under President Trump's plan, the corporate tax would be reduced from 35 to 15 percent, and personal income tax would be simplified to such an extent that Americans could “do their taxes on a large postcard." The top tax bracket of 39.6 percent would be reduced to 35 percent, and the seven current tax brackets would be replaced by three brackets with tax rates of 10, 25 and 35 percent. The estate tax would be eliminated completely. According to the Mr. Mnuchin, this mega tax reform would not lead to ongoing revenue losses. That's because the Trump administration is promising to cut down the jungle of tax loopholes and special deductions. It also assumes that this reform will lead to a permanent, 3-percent increase in the GDP, so that the additional growth would pay for these extensive tax cuts.

This self-financing will remind ordinary citizens of Baron von Münchhausen, who allegedly pulled himself out of a swamp by his own hair. Economists are more likely to think of the upside-down "U" of the Laffer curve, which was in vogue in the 1980s. The theory: tax rates are so high that an increase in rates reduces revenue, while a reduction in tax rates supposedly leads to additional revenue. Some of this is true: There is empirical proof that substantial increases in consumption taxes – like the strong increases in the tobacco tax in Germany from 2002 to 2005 – have reduced revenue in the longer term. Yet there is still no empirical proof that a significant reduction in income and corporate tax rates leads to an increase in overall tax revenues.

Even a President Trump cannot know on which branch of the imaginary Laffer curve the current corporate and personal income burden lies. As it is also not to be expected that lawmakers will be able to close all tax loopholes and eliminate all special deductions, the only certain aspect of this tax reform will likely be another substantial increase in the US national debt, which is already very high. Because the growth fairy Mr. Trump envisions will not appear, many American economists are highly skeptical of these reforms – and with good reason.

Do nothing ECB

The ECB Council met on Thursday for its regular monthly meeting and decided – nothing. All three base rates remain unchanged, and the press release stated that these base rates will remain at their current or lower level well beyond the duration of the ECB’s government and corporate bond-buying program. Because unemployment in the euro zone has been trending downward in the last four years, while inflation, based on consumer prices, is rising – reaching 2.0 percent in Germany in April and 2.6 percent in Spain - it is becoming less and less possible to remove the impression that monetary policy is now primarily concerned with fiscal relief for the highly indebted and politically shaky Latin European countries. There is truly no evidence of any risks of deflation that the ECB would have to counter with its policies.

Enjoy the long weekend, and, if you can celebrate May 1, remember that it was the labor unions that successfully fought for your holiday.