„Germany relies on lower interest rates“
Mr. Schularick, ECB President Christine Lagarde has emphasised that everything is open regarding the September meeting of the central bank. However, most analysts expect an interest rate cut. Would you welcome a relaxation of monetary policy in September?
As things stand today, I believe that would be the right move. Given the inflation outlook and the weak economic performance in the Eurozone, and especially in Germany, the extent of restrictive monetary policy is no longer appropriate.
The key question regarding interest rate cuts is, of course, the medium-term inflation outlook. Do you agree with the ECB's forecast that inflation will fall to the 2% target by the end of 2025?
I don't see a systematic error in the forecast and, as such, I generally agree with it.
This means you, like the ECB, expect wage growth in the Eurozone to weaken?
I don't observe any signs of a wage-price spiral. It is true that the loss of purchasing power over the past years is currently being counterbalanced by wage increases. This is a normal process. Additionally, consumer inflation expectations remain stable despite wage growth. Therefore, the current wage developments do not concern me.
How important is the interest rate level for German companies, especially compared to structural factors and the global economic situation?
Germany relies on lower interest rates. In previous monetary policy cycles, other countries were in the same situation. Now, given the weak economic conditions, financing conditions are too restrictive for German companies, while they are more appropriate for firms in countries like Spain. This highlights that within a currency union, it continually changes which countries find the monetary policy suitable and which do not. It is difficult to quantify the extent of cyclical versus structural factors in Germany's current growth weakness. About half could be cyclical, influenced by restrictive monetary policy and global economic conditions, while the other half might be due to structural weaknesses.
Is it solely due to the weak economy in Germany, or are there other reasons why the German economy could benefit from lower interest rates?
The construction sector in Germany has experienced a crash due to rising interest rates, which has not happened in other Euro area countries. Generally, demand for durable consumer goods falls when interest rates are high, leading consumers to defer spending where possible.
What role does the interest rate level play in consumer spending?
In Germany, consumer demand is not highly sensitive to interest rates. Factors like uncertainties regarding economic and political developments play a more significant role. But, as mentioned, interest rates do have a more substantial impact in sectors like real estate and durable consumer goods.
Regarding economic development – ECB President Christine Lagarde highlighted the downside risks for the Eurozone economy at the press conference after the July interest rate decision. How optimistic are you about the economic outlook for the Eurozone and Germany?
The global economy is characterised by political uncertainties, and that will likely continue. If Donald Trump were to implement his proposed tariff policies following a possible election victory, it would be inflationary for the US and would dampen economic growth in China and Europe. The interest rate paths of the Fed and the ECB could therefore diverge further in the future. The negative effects of tariffs on the economies in China and Europe could align with the intention behind them. Nevertheless, I am optimistic that the German economy will grow by at least 1% in 2025.
Despite the high interest rates and weak economy, the German labour market remains robust. Companies are avoiding layoffs due to demographic changes. Will this continue?
Germany loses up to half a percentage point of economic growth each year due to a lack of available labour. As you mentioned, demographic changes have prevented a more significant deterioration in the labour market. Nonetheless, I wouldn’t be surprised if we do see a downturn soon.
You have already pointed out the structural problems in the German economy. Many economists now advocate adjusting the debt brake to allow the government more room for necessary investment. What is your stance on this?
Firstly, having fiscal rules is a good idea. Otherwise, governments might have strong incentives to distribute election favours – especially to retirees in an ageing society. However, we need smarter fiscal rules than we currently have. The specifics of how these should be designed are no trivial matter, and will require time. Time that we don't have for military expenditure. Therefore, I am in favour of excluding military spending from the debt brake for a certain period – perhaps ten years. Given the low level of public debt, we have the fiscal room for this.
Why specifically mention military spending?
A Russian victory would undermine current fiscal debates. We need to support Ukraine more robustly. Additionally, military investment needs are very high. Instead of 50 billion euros per year, the Bundeswehr would need 100 to 150 billion euros. This cannot be saved elsewhere. Tax increases to finance these expenditures would be detrimental to the economy. Moreover, additional military spending could have positive effects on economic development.
Would you exclude spending in other areas from the debt brake?
No, but we should discuss a reform of fiscal rules. Investing more in Germany is essential, but how best to do this is complex. The state should certainly engage more private capital than it currently does. For instance, in areas like fiber optic expansion. Over-bureaucratization also hinders investment and needs to be reduced. But that’s not an easy task as well. Thus, I don't expect quick results.
