ECB Says Germany Could Boost Euro-Area Growth by Borrowing More

  • Schaeuble aims to maintain balanced German budget in 2017
  • Higher German spending would give euro area short-term boost

Germany could give itself and the euro area a boost if it takes advantage of low interest rates to finance a public-investment program, the European Central Bank said.

That’s the key finding from an ECB study released Monday that simulates the effect of an expansion of public investment equal to 1 percent of gross domestic product over five years in a large euro area country such as Germany. It concludes that the stimulus would have a greater impact if it were financed by debt or higher revenue and accompanied by an expansive monetary policy.

“An increase in public investment will have the strongest short-term demand effects, including in terms of spillovers to other countries, with an anticipated accommodative monetary policy,” according to the study. “This finding strengthens the case for increasing public investment in the current low-inflation environment.”

Policy makers outside Germany, Europe’s biggest economy, have been pushing the country for years to increase spending to help boost growth across the region. That’s at odds with Chancellor Angela Merkel and Finance Minister Wolfgang Schaeuble’s election promise of continuing to maintain a balanced budget even in the face of increased spending for the refugee crisis and negative rates on some German debt. Schaeuble will outline the government’s 2017 spending priorities on Wednesday.

The simulation in the ECB study, published in an ECB bulletin that the bank’s Executive Board signs off on, shows that more investment in one country results in a “positive, short-term output stimulus” for the rest of the euro area.

“A debt or revenue-financed increase in productive public investment implies significantly larger short-term output gains compared with an increase in investment financed by cutting other public expenditure,” according to the report.

However, the effects are not fully self-financing and lead to higher public debt in the long term. That’s why a loose monetary policy is important.

If “monetary policy does not accommodate the shock but, instead, raises interest rates in response to the higher inflation risks posed by the short-term increase in demand, the pick-up in both private consumption and investment becomes more muted and this, in turn, limits output gains in the short run,” according to the study. “Under this scenario, there will be a less favorable public debt development over the entire simulation horizon.”

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