Path Dependent Economics: Explaining Differences in German & US Reactions to Financial Crisis Prof....

Path Dependent Path Dependent Economics: Explaining Economics: Explaining Differences in German & Differences in German & US Reactions to Financial US Reactions to Financial CrisisCrisisProf. Stephen J. SilviaSchool of International Service,American University

Indiana University, 8 April 2011

Silvia-Indiana U-8 April 2011

Introduction Paper compares elite

conceptualizations in three recent episodes of economic crisis: 2008-2009 Financial Crisis Contents of the stimulus packages Euro crisis

It finds that constructions and pre-understandings affect both the preferences perceived as serious and the ordering of those preferences

2

Financial Crisis: Domestic Consensus, Transnational Divergence Elite reaction to recent financial crises do not align

transnationally along ideological lines. Instead (esp., among economists), broad consensuses formed

nationally that spanned ideologies, but sharp divides arose between countries: Not only Paul Krugman and Joseph Stiglitz, but also Martin

Feldstein and Ben Bernanke called for accommodating fiscal and monetary policy.

Not only Wilhelm Noelling and Joachim Starbatty, but also Michael Burda and Jürgen von Hagen voted in favor of a statement against creating a European Stability Mechanism.

No significant difference between the policies of the Bush and Obama administrations.

The German Grand Coalition (i.e., Christian Democrats and Social Democrats) also saw eye to eye, but their choices did not align with the United States.

Why?

Silvia-Indiana U-8 April 2011 3

Financial Crisis: Domestic Consensus, Transnational Divergence It is NOT

differences in the severity of the crisis. Crisis and

bounce-back slightly bigger in Germany


Financial Crisis: Domestic Consensus, Transnational Divergence Germany and the United States have very different understandings of the “decade of extremes” (i.e., the 1920s).


Constructed Understandings in Germany and the United States USA: Great Depression was the biggest crisis;

unemployment and deflation were the biggest problems: Unemployment hit 25 percent. Prices fell by 30 percent.


Constructed Understandings in Germany and the United States Germany: The Great Inflation of 1923 is seen

as the biggest crisis.


Constructed Understandings in Germany and the United States The United States has never had a great

inflation. Germany DID have high unemployment in the

1930s, BUT the phrase in German for the Great Depression is the “World Economic Crisis,” which externalizes its causes.


Constructed Understandings in Germany and the United States: Economists USA: “Americans are from

Keynes.” “Saltwater” Economists:

(Neo) Keynesians on the East and West coasts.

Freshwater Economists” Chicago School neo-monetarists.

BUT, both schools accept a common objective of demand management.


Keynes

Constructed Understandings in Germany and the United States: Economists Germany: “Germans are from Hayek.”

Government should maintain “framework conditions” for market competition, and have a very minimal safety net for the “losers” (“ordo-liberal” Freiburg School).

Governments only exacerbate misallocation (e.g., create bubbles) and prolong economic crises when they attempt to manage demand, so they should not try it (Hayek).

The predominant German position is very much like the argument in favor of “shock therapy” for Central and Eastern Europe immediately after the end of the Cold War.


W. Eucken

F. v. Hayek

Financial Crisis: Domestic Consensus, Transnational Divergence The transatlantic

divergence among economists is all the more striking given the widespread public skepticism regarding stimulus and transfers in both countries.


Policy Responses to the Financial Crisis Politicians in both countries endeavored

to strike a balance between their publics and experts. US Stimulus Package:

Content: Infrastructure programs, tax cuts, aid to states, cash for clunkers

Debate over size of stimulus package. German Stimulus Package:

Some infrastructure, tax cuts, cash for clunkers and short-time work (i.e., government subsidies allow people to work half-time but be paid 70-80% of their full-time wage).

Both stimulus packages are consistent with the depictions of the economies in the “varieties of capitalism” literature: USA: Liberal Market Economy. Germany: Coordinated Market Economy.


Germany’s Response to the Euro Crisis The euro crisis has proved far more intractable

for German policy-makers. The German government has three objectives:

1. Maintain the euro as a stable currency.2. Maintain the stability of the European private-sector

financial system (esp., German banks).3. Keep fiscal decentralization (i.e., no sovereign or

cross-national bailouts). Germany’s problem is that under current

circumstances (i.e., sovereign debt crisis and exposed domestic banks), these three objectives are incompatible.


Germany’s Response to the Euro Crisis Transatlantic Divide

among Economists: US economists argue that

Germany benefits from large euro area (e.g., Barry Eichengreen and Adam Posen).

Most German economists denounce EFSF and ESM.

German government reluctantly approves bailout mechanisms, but adds conditions to appease public and professional critics.

Silvia-Indiana U-8 April 201114

Conclusion Economics, like the natural

sciences, often appears to be completely objective and transnational.

The financial and euro crises demonstrate that understandings within epistemic communities (in this case the community of academic economists) still have a tremendous impact on shaping preferences.


Path Dependent Economics: Explaining Differences in German & US Reactions to Financial Crisis Prof....

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