High-level gatherings on the edges of the spring and annual meetings of the International Monetary Fund (IMF) and the World Bank in Washington have become a source of frustration for German government officials. The pattern is predictable: before setting out, the German Finance Minister packs his suitcase full of reasons why the world should at last recognize that the euro zone is on a slow but steady track out of the crisis. The Finance Minister, Wolfgang Schaeuble prepares his argument − Europeans have agreed to a set of stringent budget rules laid out in the fiscal compact; Berlin has agreed to strengthen the firewalls; and the reform process in both Spain and Italy is on track. What is needed now, he will urge, is some time, and an end to the endless speculation about what more is needed. Some praise should be in order.
But Schaeuble will be disappointed.
The IMF has put three topics on the agenda that, for domestic reasons, Berlin is still not ready to discuss in public − namely a relaxation of budgetary constraints on Europe’s peripheral countries, particularly Italy and Spain; secondly, using funds from the European firewalls to inject capital into weak European banks; and, thirdly and most importantly, the introduction of Eurobonds, as part of a bolder move towards further European fiscal and political integration.
According to the IMF, neither Italy nor Spain will meet its deficit targets, not this year, and not in 2013. But instead of advocating more fiscal discipline, the IMF, backed by U.S. Secretary of the Treasury Timothy Geithner, is urging Europeans not to tighten the screws further. Too much fiscal adjustment, they argue, will strangle the economy. The focus should be on the reduction of structural deficits, reforms and growth. This message is welcomed in Madrid and Rome, but Berlin, of course, is a different matter.
While the German government has realized that an unyielding and exclusive focus on austerity is counterproductive, German public opinion has not yet reached that conclusion. In fact, even the German government is increasingly under domestic pressure for not pursuing more ambitious spending cuts in its own budget. Not surprisingly, Chancellor Angela Merkel’s government is still officially committed to strict fiscal discipline. In reality, Germany is taking full advantage of robust tax revenues and very low debt financing costs, and it is relaxing its grip on its fiscal purse. Merkel is trying to keep domestic demand strong. It not only supports Germany’s economy while neighbors gripped by recession stop buying German products, it also helps those very same neighbors to export more to Germany. Berlin is trying to help in many ways, some of which go well beyond what German citizens are prepared to stomach. Merkel’s government has even tacitly accepted that inflation may need to be higher in Germany than in those countries undergoing painful economic adjustments in order to lessen the competitiveness gap between them and their powerful neighbor to the North. It is not an easy balancing act for the German Chancellor. After all, Merkel has to keep the distance between what she says and what she does within reason to keep her politics credible.
This makes the renewed calls from the IMF for Eurobonds even harder to stomach. For Berlin, Eurobonds are not a natural part of the agenda − the talk about Eurobonds is described as “premature.” Talks about further European integration have stalled, particularly in light of upcoming French presidential and German local elections. Merkel’s government will steer clear of these controversies and wait for the voters’ verdict.
The same applies to the last point the IMF put on the agenda: using the firewalls to not only help sovereigns but also banks. The Fund’s objective here is not only to break the negative feedback loop between banks and sovereigns, but also to reverse the renationalization of the European banking system, which has occurred in recent months and is tightening credit in those countries which badly need it. To some degree, the IMF plays into the hands of the European Central Bank (ECB), which is also trying to press politicians to share more of the burden of steering the euro out of troubled waters.
On Thursday, just hours before the arrival of the government delegations from Europe, the fund’s Managing Director Christine Lagarde delivered a stern warning to her continent by reminding Europeans that despite recent improvements, dark clouds could gather very quickly. After all, in the IMF’s assessment, the biggest risk to the world economy remains the euro zone. If the bloc’s politicians hoped to reap praise while spending this weekend in Washington, they will be disappointed. What they will take back home instead is more work to be completed in a timely manner. That is not the message they wanted to hear.