Germany's Real Business Cycle

Germany’s large manufacturing sector has done poorly during 2019. As a result, many are calling for fiscal stimulus:

Germany is the economic engine of Europe — and it’s running on fumes. After a decade of near-constant expansion, the economy is flirting with recession. Germany’s export-dependent companies are deeply exposed to fallout from rumbling trade disputes, and the critical auto industry is struggling with the shift to electric cars. That means pressure is rising on the government to abandon its longstanding aversion to splashing the cash. Will Chancellor Angela Merkel loosen the purse strings to give the economy a shot in the arm — and would it be enough?

Germany should resist the calls for fiscal stimulus. Instead, it should call on the ECB to adopt a more expansionary monetary policy. But even if the ECB continues to undershoot their inflation target, fiscal stimulus is unwise and unnecessary.

The recent slump in German manufacturing is a real shock, partly fallout from the US/China trade war. Real shocks tend to be much less harmful than nominal shocks, especially for large diversified economies. Thus even though German manufacturing has recently been weak, the German labor market continues to be quite strong. Here’s the unemployment rate in Germany over the past 12 months:

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The goal of macroeconomic policy is not to prevent all fluctuations in real output, rather the goal is to prevent fluctuations caused by the interaction of sticky wages and unstable nominal GDP. It is possible that Germany will eventually face a nominal shock, but as of today, there is no need for stimulus in Germany.

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