For a number of years now, Europe’s EMU has been seen skating along the abyss, suffering its worst economic crisis since WWII and flirting with outright deflation and/or breakup. The fragility of the euro currency union has been a cause of instability across Europe and beyond. The argument advanced in this paper assigns Germany a leading role in the tragedy of supposed virtues turning out to be vices that have brought Europe to its knees. It ascribes a critical weight to the “power of ideas,” particularly Germany’s oddly anti-Keynesian views on matters of macroeconomic policy. 

The ideas that brought wreckage to Europe have historical roots though: the success of the German model that was the basis of West Germany’s postwar “economic miracle,” its rise to prosperity and respectability, and eventual (re-)unification in 1990. Unfortunately, Germany has never fully understood the true sources of its success and learned the wrong lessons from its own economic history. 

A peculiar monetary mythology has been at play here that justified the Bundesbank’s stout anti-inflationary bias. This approach brought fame to the Bundesbank itself and German pride in the soundness of its Deutsch mark. Importantly, for a long time the Bundesbank’s distinctive brand, its bias against (hyper-)inflation, and Germany’s stability culture did not hinder but even supported German growth: export-led growth. For in the context of pegged nominal exchange rates, achieving a superior (lower) inflation record translates into competitiveness gains. In this way, (West) Germany learned to live quite well without Keynesian demand management. The Bundesbank’s real role was to enforce discipline—superior (“German”) discipline in the form of wage moderation and balanced budgets. Effectively, Germany took Keynes’s diagnosis of mercantilism in chapter 23 of the General Theory to heart, but ignored the remaining 23 chapters, thereby getting away with it by relying on others to do the real job. 

The German model was launched, innocently enough, with the balance-of-payments crisis of 1950–51, when boosting exports was an urgency. It became a notorious habit—a habit that is intricately interwoven with Bundesbank mythology and which Germany cannot let go of. Somehow it all also seemed to confirm the supposed wisdom of ordoliberalism, so that an element of path dependency in policymaking made Germany a difficult place for Keynesian ideas to penetrate, and lastingly so. 

Europe’s tragedy is that under the thick fog of its monetary mythology, Germany failed to appreciate that the success of the German model critically depends on others behaving differently from itself. Exporting the German model to Europe was begging for trouble, and featured a fallacy of composition: Germany’s export engine would stall when everyone becomes just like Germany. 

Germany’s reaction to underbid its own model backfired badly. At first it primarily made Germany itself “sick.” When intra-union imbalances later unraveled, everyone else was found to be lacking competitiveness. And so Germany prescribed more of the same sickening medicine for everyone. 

Germany’s distinctive anti-Keynesianism costs Europe—and ultimately Germany itself, haunted by its “euro trilemma”—very dearly. 

Even 80 years after the publication of The General Theory, there is still a lack of appreciation of Keynes’s rationale for apparently using a closed-economy model in his most famous work— which he hoped would stop policymakers from engaging in the kind of folly that has brought Europe to its knees. 

Asymmetric adjustment (of debtor countries only) and an inadequate macro policy stance continue to hold back recovery in the eurozone. While the ECB has belatedly begun to play a more constructive role in sustaining the euro (Bibow 2015, 2016), the euro’s fiscal regime remains deeply flawed. Representing a minimalist fiscal union, the “euro treasury,” which I proposed elsewhere (Bibow 2013b), would complement the euro monetary union.  

You can read the whole paper here.