Philippa Sigl-Glöckner on the Debt Brake, German Fiscal Policy, and Full Capacity Utilization

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Philippa, welcome to the show.

Philippa Sigl-Glöckner: Yeah, thank you very much for having me.

Beckworth: Glad to have you on, and I want to give a shout out to Sam Bell who connected us and thought this would be a good show, and it will be a great show. I read your paper, *A New Fiscal Policy for Germany*, very interesting, and I think we're going to learn a lot about fiscal policy as it applies to Germany, the Eurozone, broader applications than just the good old US of A here that many of the listeners probably know well. So, before we do all that, why don't you tell us about your think tank? I probably butchered the name so maybe you can pronounce it properly, tell us the history of your think tank, and then maybe we'll jump into your career journey as well. But first, tell us about your think tank.

Sigl-Glöckner: First of all, apologies for picking such an incredibly German name. Dezernat Zukunft basically means the Department for the Future, and why we picked that name was, at the time we were thinking maybe we should do something, set up a think tank or some kind of policy forum, I did my MSc thesis at the German central bank, the Bundesbank, and the departments there are called Dezernate, it's basically very bureaucratic name for department. So then we thought, "Well, the Budensbank really needs one for the future, that looks forward," and then we just kind of pinned an additional one to the organization chart and called it Dezernat Zukunft, and then we thought, "Okay, let's use that as a name for our think tank," that, as the kind of subtitle says, focuses on macrofinance.

Sigl-Glöckner: And I started it with a couple of friends, most of whom actually had also studied abroad and came back to Germany at some point. And we all came back with all these questions on why Germany is pursuing the fiscal policy it does, and see some things slightly different, at least compared to the US. And then we thought, "Well, first we need a place where we can discuss all these things and try and understand what's going on, and then maybe eventually come up with new ideas." And we are all between economics and politics and political theory, so we were all grappling with this whole thing of having underlying norms that you don't make explicit.

Sigl-Glöckner: So we thought, "All right, let's put them up front and make sure that everything we do builds on these norms, and use norms that most people will say yes, they agree with, so they basically don't stop listening to us when we say what our normative assumptions are about the work, and what economic policies we should pursue. At least three norms or values were dignity, prosperity, and democracy. We think that the vast majority of people in Germany, Europe, probably the US, will agree that these values are important. And then we set it as our task to think about economic, especially macroeconomic policies that bring us closer to those values.

Beckworth: So the paper we're going to talk about deals with Germany, but does your work with the think tank also provide policy advice for the EU more broadly?

Sigl-Glöckner: Yes, and I think we'll get into this a little bit when we talk about the paper. I mean, I think talking about macro policy or thinking about that in Germany, you really have to think about Europe, because we're a very integrated economy. But very much on purpose, we started in Germany, gave ourself a German name, wrote our first paper, which was incredibly hard or big paper in German, because we realized that the anglophone debate and the German debate are often very, very separate, and they don't really translate. I mean, I studied abroad, so for me it's very easy to think in English about these things, sometimes even harder in German, but I'm not sure. You're sometimes a bit fast in assuming that it's just that easy for everybody else, and they should just understand English papers, and hence we write in English, we thought if this is where we want to open up the discussion, then we should start in Germany, but then obviously we want to broaden it out to Europe.

Beckworth: Tell us about the think tank space in Germany. So in the US, there's a lot of think tanks, there's many in Washington, DC, and in other cities as well. But I see it as a very healthy environment, there's competing views, competing perspectives from different think tanks in the US. Do you find something similar in Germany, or are you kind of like the avant-garde, the cutting edge? Are you entering and developing a new space there, or is it well-developed?

Sigl-Glöckner: The whole think tank community is much, much smaller in Germany. I mean, first of all, we're a smaller country, but secondly, also, I'm not sure there's the same tradition as you have in the US and in the UK, where you have a really kind of lively community of think tanks that kind of fight about policies, and then at some point they enter the political process. Here, I mean, we're still trying to discover, actually, how ideas and politics come up and are developed. And the debt brake, which we will talk about later, actually kind of started in a ministry, interestingly enough. Didn't come from outside, from what we understand. So this space is really kind of in a much earlier stage, which means you have a really interesting playing field, lots of things to do, you can kind of innovate and play around, but also makes it a bit harder, because you don't have that many partners you can talk to, for instance, or who you can fight with to make your ideas a little better.

Beckworth: Yes, so you are definitely clearing a new path, you're making way for the think tanks in Germany, so congrats to you and your new think tank over there. Let's talk about you a little bit, what has your career journey been like? I know you've worked at the World Bank, you've worked in the German finance ministry. So how did you get on this career path, and how did you eventually end up as the leader of the think tank?

Philippa’s Career Journey

Sigl-Glöckner: I'm not the only leader of the think tank, we're really a team, but we have different functions, and I might be the one who talks most to the public. To go to my career path, so I studied philosophy, politics, and economics, I mean, fantastic undergrad, because it forces you to look at the world from all these different sides. And I mean, basically I was always surprised, I really liked political theory, and I really liked macroeconomics, because it's two ways where you think about politics in quite intense way.

Sigl-Glöckner: And when you're in political theory, everybody thinks really hard about all these values, and how do we create good individuals who are free to make their own choices, [inaudible], how do we have a good society? And then in macroeconomics you talk about money and rational human beings and that's it. So I was kind of interested in the disconnect between the two, and then I thought, "Well, politics is really the space where you need to bring the two together and make them coherent." So I thought it would be interesting to work on political ideas, but then from a money angle. Because this is really one of the biggest tools that we have in government. I mean, you can also just set a law, but most things today, even the government, are directed through money. So then I thought, "How can you try and bring the two together?"

Sigl-Glöckner: So that interplay between money and what do we want a good society to look like, that always really interested me from the beginning onwards. Then, I started in the private sector, actually, because I thought it would be good to understand the economy before I talk about it. In management consulting, focus on telecoms, which was interesting, because you see a lot about the kind of market we think about when we talk about capitalism, people buying mobile phone contracts, trillion contracts going in and out every day, products being optimized like crazy. And then on the other hand, you have infrastructure, regulation, and government. So you learn about all this stuff. At this point in time, I thought everything at home was fine. I mean, I come from Munich in Germany, which is, most of your listeners will probably know because of the Oktoberfest. It's a pretty wealthy city, so I was like, "Everything is fine at home." When I think about these problems, you really want to help in countries where stuff isn't going that well, and I was particularly fascinated by Sub-Saharan Africa.

Sigl-Glöckner: So I was kind of thinking about these things, then I was able to work on telecoms in Africa, in management consulting, so had a great time there. But then kind of wanted to make the next step to the policy side, and that's how I arrived at the World Bank, actually. So I started there on the whole digital side, so what can we do with mobiles and development, and then ended up, because the World Bank was doing a big reform, in the president's office actually working on yeah, how can we affect the development finance? So yeah, that kind of went a little bit faster than I thought, but allowed me to really see that finance-politics interaction from a few different angles.

Sigl-Glöckner: And then you might ask, "Okay, so how did she end up in Germany and back home doing all this?" And basically, at the World Bank I had a very, very interesting time, and in the end, the Ebola crisis happened. And I was, by chance, someone who had some work experience in West Africa, because I had worked there basically in private sector development on the side, and then they were like, "All right, we need someone who kind of understands this, who can talk to other people," to send to the UN to coordinate between the World Bank and the United Nations in the Ebola response. And that was me, and that was very interesting, but also, in a way, quite shocking.

Sigl-Glöckner: In development, when stuff goes wrong, it's about the long term. It's not great, but the harm you do is not so immediately visible. In a crisis like the Ebola crisis, or I mean, now we all see a pandemic firsthand, you can sometimes connect people dying pretty directly to your actions or the actions around you. Under my view, I saw a lot of that happening, unnecessary death because of the way the international system acted, and then I was like, "All right, I think I have to leave this, but I still really like development, so maybe I can work for a government or support a government in one of these countries that I'm interested in." And then got the opportunity to work in Liberia, in West Africa, in the finance ministry.

Beckworth: Really? So you've been all over the globe, working in finance ministries, industry, working with pandemics. So you have quite an impressive resume. Now, you ended back up at the central bank in Germany, the Bundesbank for a little bit too, correct?

Sigl-Glöckner: A little bit. I mean, that was really for my master's thesis.

Beckworth: Okay.

Sigl-Glöckner: But that was kind of my first step back into Germany, because when I was in Liberia, the debt crisis in Europe happened, and that's where my initial hypothesis, everything is fine in Europe, you don't have to worry about this, I was like, "Ah, maybe you were wrong there." And then I decided to basically go back to Germany, and then I wasn't quite sure whether central bank or ministry of finance, so went to the research center of the Bundesbank first to kind of try that out, and then, yeah, ended up at the ministry of finance.

Beckworth: Okay, and then you ended up, after that, at your think tank, which is where you are now. And just to be clear, one last question on your think tank, the work that you do in terms of topics, I mean, this paper we're going to discuss is about fiscal policy, but are you guys also interested in what the ECB does, are you going to write anything on monetary policy, too? How wide do you cast your net, I guess, at the think tank?

Sigl-Glöckner: Yeah. Well, you do have to kind of cast it quite wide, right? Because all these things are connected, and I mean, monetary and fiscal policy for sure. And we see it more as an artifact of how academia has developed that the two are so separate. So we are actually, really, really proud, and it's a great question to get today, because we have our first central banker onboard, or he's currently on leave from the Bundesbank, so we can cover that side properly. We really think we need to think the two together. So for sure, we are covering monetary policy, fiscal policy, and then financial system, because the three are really inseparable in a way. And then you even have to go to some real economy topics, if you want, like the labor market and climate. Our problem is more like, we can't do all of that at once. It’s wherever it leads us to come up with good, coherent ideas that really work for policymakers.

We are covering monetary policy, fiscal policy, and then financial system, because the three are really inseparable in a way. And then you even have to go to some real economy topics, if you want, like the labor market and climate. Our problem is more like, we can't do all of that at once. It’s wherever it leads us to come up with good, coherent ideas that really work for policymakers.

Beckworth: Okay, well, let's get to your paper. It's coauthored with some of your colleagues at the think tank, and the title of the paper is *A New Fiscal Policy for Germany.* You ask three big questions, I'll just mention them now, we'll come back later and address them, but the three questions you ask are: what is the right objective for fiscal policy, what institutional framework is needed to implement that right objective for fiscal policy, and then what concrete, politically realistic reforms could happen in Germany to push the country in that direction? So those are the big questions that you ask. But before we get into them and how you address them in the paper, maybe it'd be useful for our listeners, definitely for me to learn a little bit more about Germany. What's the historical context, what's the fiscal policy like currently? Maybe walk us through that so we can understand the motivation and the story behind your paper.

German Fiscal Policy, Its Historical Context, and the Debt Brake

Sigl-Glöckner: Sure. So Germany, especially, I mean, when you come with a US perspective, has quite a special, I guess, history in fiscal policy and that area. That’s even being picked up by your foreign exchange report of the US government, so it kind of sticks out. Germany is quite keen on not having too much debt, quite worried about big deficits. Now, in the past, has been kind of claimed to be the one that pushes austerity in Europe. Maybe actually the story is a little bit more complicated, but I guess in general Germany has a fiscal framework that’s primarily concerned with preventing too much debt from happening, and hence in our constitution, we have a deficit limit specified, which I think is quite special, in a way.

In general Germany has a fiscal framework that’s primarily concerned with preventing too much debt from happening, and hence in our constitution, we have a deficit limit specified, which I think is quite special, in a way.

Beckworth: So it’s actually in the constitution, a rule that governs fiscal policy. It’s very detailed, which is unusual for a constitution of a country, right?

Sigl-Glöckner: Yeah, exactly. I mean, you would think it’s like the high level outlines, and you could maybe even say something like, “You should not go into too much debt,” but it’s a lot more specific than that. It really says 0.35% structural deficit, plus cyclical adjustment. I mean, imagine having that in your constitution, that’s quite something.

Beckworth: Yeah, that is fascinating. And I guess a follow up question would be, why is it in there? And as you mentioned, Germany has historically been very concerned about deficits and debt, and is it fair to say that that concern comes from a desire to avoid the hyperinflation of the 1920s? Is that where this deep-seated fear originates, do you think?

Sigl-Glöckner: That’s kind of the popular history, and that’s what people say, and why they say, “Well, we can never change anything without this.” And by now, actually, I think it is the reference frame in people’s head, that’s the worry they have in the end. When you ask some historians, who know all of this a lot better than I do, and Philipp Heimberger, who’s actually an economist, but looks a lot at these historical things, the story is a lot more complicated than that. We try to kind of trace the debt brake, which is what this clause in the constitution is called, to trace it back to its origins and where it really comes from kind of in the near term rather than the popular history of psychology of a nation, which I’m never quite sure about. I mean, maybe there is something like that, I just don’t really know. But there’s some kind of explanations that are much closer in time. And basically, now when you trace it back, it originates I guess in the ‘90s, where we had quite fast rising debt after the reunification of Germany, where you kind of needed a lot of investment. And then what finally made it happen was the financial crisis.

Beckworth: Huh. So tell us again how this debt brake works. I know you gave the details, but one more time, kind of flesh it out for us, what is it, what does it do, and how is it a change from what was existing previously?

Sigl-Glöckner: So first of all, it’s a fantastic misnomer, because it doesn’t actually stop debt. I mean, no one can actually stop national debt from going to a certain level, that’s a bit of a control illusion. It limits the annual deficit that’s incurred within the budget. So it can also do off-budget stuff, but it limits your budgetary deficit to 0.35% at the federal level, plus, and then it has a very weird kind of clause that says plus you’re allowed to counteract any deviation from the normal state of the economy. Which is really not very tangible, then it translates into a hard quantity constraint in kind of further simple legislation, but that’s the basic framework. So basically, you’re limiting the deficit, but you try and be a little bit responsive to what the state of the economy is.

Beckworth: So during a recession, for example, then this debt brake has a release valve, pressure can be taken off of it because you’re in a recession, you can run a little bit more debt, and then during a boom would be the opposite of that, I’m assuming. You want to stay close to potential GDP in terms of the size of the fiscal deficit, is that right?

Sigl-Glöckner: Yeah, so there are kind of two things for the recession, and the question, we have a very interesting constitutional debate about this right now is, we have a normal recession, so there you have to stay within these limits and do all your potential output calculations and that stuff, and then you have big crises. And for big crises, you can actually suspend the deficit limit and kind of do whatever you want, and that is what’s happening at the moment. So then, when you put that in your constitution, you want to make really sure that you’re able to differentiate the normal downturn from [a] boom.

For big crises, you can actually suspend the deficit limit and kind of do whatever you want, and that is what’s happening at the moment. So then, when you put that in your constitution, you want to make really sure that you’re able to differentiate the normal downturn from [a] boom.

Beckworth: Yeah, how do you define those two?

Sigl-Glöckner: How do you define those two? So there is a, yeah, smaller or bigger debate going on right now. In the past, I think what everybody thought would be the differentiator was for the big crisis, something really acute, unpredictable, happening right now. So pandemic, where you have high infection rates right now, that was pretty obvious. Natural disaster was always the example that was given by lawyers. Interestingly enough, the debt brake only started really kind of being enacted after the crisis, but the financial crisis would’ve also been an example. The problem is first of all, so what do you do, for instance, in a year like 2021? Where the pandemic isn’t so bad anymore, so is that really still a kind of natural disaster or not? Or is this just the economic slump that you now need to counteract? So it’s really, really difficult that it’s one of the biggest debates we have in the country right now.

Beckworth: Okay, so you have this framework in place, it’s in the constitution which is pretty striking. You’ve got the debt brake, has a cyclical component to it. What did this mean in practice for Germany last year? So we have the pandemic, as you know in the US, fiscal policy was very generous, relative to historical practices. We got bit stimulus checks, federal unemployment insurance was added on top of the state unemployment insurance. So there was a lot of new ground that we broke, I think, in terms of fiscal policy during this pandemic. What did Germany do? Anything similar?

Sigl-Glöckner: Yeah, so definitely not in size. The US is a completely different world, so our deficit was about half as large as yours, or a third, I think, even. So much, much smaller. But that wasn't limited by the debt brake, because in that kind of situation, when it really hit and sprang, when we all started realizing how bad it was, I was still at the ministry back then, then basically you go to parliament, you say, "We need to suspend the debt limit, and we need to take on additional debt." And then that's not very hard to get through, so they did that, and they even did it again for this year.

Sigl-Glöckner: So at the moment, it's not really the debt brake that's limiting us, and actually the government always asks for more fiscal space than what they use, in the end. I think what really the big difference is between the US and Germany is that we still don't really like to spend it, so we actually use much less of the space than what we asked for, in the end. It was more like to get a reserve capacity, because otherwise you may have a problem with the fiscal rules after the pandemic. So your stimulus was a lot bigger, is a lot bigger this year, and I don't think we would send checks to households.

At the moment, it's not really the debt brake that's limiting us, and actually the government always asks for more fiscal space than what they use, in the end. I think what really the big difference is between the US and Germany is that we still don't really like to spend it, so we actually use much less of the space than what we asked for.

Beckworth: You had something different, as I understand, short-term work benefits? So how did those operate?

Sigl-Glöckner: Yeah, I think they are actually a fantastic automatic stabilizer. We already had some experience with them during financial crisis. So basically what happens is, the government pays for, I mean, not the entire, but a large share of the wage of workers if a company reduce their hours, but still kind of keep them on. So you prevent, a little bit, companies from firing all their staff, and ensure that people have an income and can continue on through the crisis, and the government just pays their wage or part of the wage.

Beckworth: So it's a different way to do what we did in the US, in the US we gave money after they lost their jobs, and in Germany you're giving money to keep the job, so maybe it might help with the recovery, people still have a job, they're not searching for work afterward. So there's, I think, an interesting conversation there to be had over what was the most efficient use of that fiscal space. But what's interesting, as you mentioned, is that Germany, even though it got more fiscal space, it didn't use it all. It's very, very tepid, very concerned.

Beckworth: And one last question on the historical context, I'm going to go back to this question I asked earlier, the popular narrative, as you said, is hyperinflation in the 1920s, right? You got to be careful, we got to avoid that, even though history's more complicated. Fair enough. But if we're going to invoke the 1920s, hyperinflation, it seems just a reasonable to me to invoke the late 1920s deflation, when the Great Depression kicked in, and helped usher in Nazis, and some of the less savorable parts there. So why do you think the popular narrative remembers the hyperinflation more than the deflation?

Sigl-Glöckner: I mean, this is really just speculation, because I'm not a historian, but I think because that story has been told over and over again. And I think there were people who had a very focused agenda on kind of basically ensuring Germany doesn't take on that much debt. When you look around, I mean, it's not just that we have the debt brake in the constitution, also the kind of reporting that the ministry of finance does is very much focused on that worry. We don't really worry so much whether we spend the money well on a certain project or not, it's all about fiscal sustainability and the debt to GDP ratio, which is kind of the big thing, is limiting debt to GDP to 60%. So I think you can see that for the past, I don't know, 30 years, people have been working very, very hard to instill that narrative, put it in people's heads.

Sigl-Glöckner: And maybe, to just add a last thing to that that kind of speaks to it is, you have the debt brake in the constitution, but you actually have a much more powerful political symbol, which everybody here on the street will mention to you when you ask them about fiscal policy, and that is the black zero. I don't know whether you've heard about this, but basically it was the kind of big symbol of our last finance minister, Wolfgang Schäuble, who said the primary goal is the black zero, so your budget, you want to have at least a small surplus. When he left the ministry, the whole staff lined up outside to form a black zero, and then they took a picture-

Beckworth: Wow.

We don't really worry so much whether we spend the money well on a certain project or not, it's all about fiscal sustainability and the debt to GDP ratio, which is kind of the big thing, is limiting debt to GDP to 60%.

Sigl-Glöckner: ... from the air, and they were like, "This is what we are proud of."

Beckworth: Okay. So it's a culture, it's kind of a popular understanding, and as they say, history's written by the victors, in this case, the people who have won the debate, who've won the narrative, who've been victorious in shaping the way to think about things. So you have your work cut out for you there. So let me move on, then, to what you list as the current challenges for Germany. So we'll get, again, to the prescriptions of your paper in a minute, but you list three current challenges for Germany, and I'll just briefly mention them, and maybe you can speak to them. Number one is decarbonization, the second one is demographic change, and the third one is long-term stabilization of the external balance. So tell us why these are challenges for Germany currently.

The Three Big Challenges for Germany

Sigl-Glöckner: I think decarbonization is a shared challenge that we all have, but [like] the US, we're really an industrial economy, maybe even more. For us, exporting high quality industrial goods, machinery is really what kind of drives the economy, and especially what creates really all the good jobs in the country that are very stable and well-paid. So decarbonizing that kind of economy, and an economy that also likes cars and sells a lot of them, is quite challenging.

Sigl-Glöckner: And we're new to this area, so when we saw the numbers, we were quite stunned. But over the last 30 years, we managed to reduce carbon emissions by 40%, but now we have to do 25% in 10 years. And in the past, we had the complete breakdown of industry in Eastern Germany, so basically deindustrializing a large part of the country, I mean, by accident, and that wasn't great, but it really helped with this. So we have a huge, huge challenge, we just need to become a lot faster in transforming our economy. So that's quite tricky and requires a lot of investment, and I think political skill. So yeah, that's the first one, and quite a big one. Demographic change, second one, we're a rapidly aging society, and that just means people will not work for a long time in their life, and people who work need to kind of make sure that we have enough wealth in the country to go around. So in a way, the question is do we need to be looking at Japan to see what we can do?

Sigl-Glöckner: And then yeah, you mentioned the external balance. I mean, Germany's very proud of being the export Weltmeister, world champion at exports, at running a current account surplus. That is why the US puts this in their foreign exchange report with the debt brake, because they're a bit skeptical of that, us basically getting all demand from abroad. I think, I mean, from a German perspective, it's quite dangerous, and we saw it last year, because it means if demand in other countries breaks away, we are very exposed, and there's not very much we can do, because you don't have that strong consumption drive domestically.

[Like] the US, we're really an industrial economy, maybe even more. For us, exporting high quality industrial goods, machinery is really what kind of drives the economy, and especially what creates really all the good jobs in the country that are very stable and well-paid. So decarbonizing that kind of economy, and an economy that also likes cars and sells a lot of them, is quite challenging.

Beckworth: Okay. So your paper is going to speak to policies that can address these challenges, and decarbonization is, I think it's pretty obvious what fiscal policy can do to invest in green technology. Your third one, dealing with the current account surplus, that's also related to fiscal policy. But demographic change, that's a problem that's everywhere in the advanced world. I mean, the US, our fertility rate's going down, population growth rate's going down. Sadly, we're not as excited about immigrants as we used to be. I mean, all the things you need to offset demographic change just are moving in the wrong direction in the US, and I think around the world. Even China, the one child policy's coming back to really hurt them. Do you see any meaningful way to turn demographic change around? I mean, is that something fiscal policy can actually address?

Sigl-Glöckner: So first of all, that's actually why we kind of singled it out as the key issue, we have to. If we really think that sustainable finance is something we should be looking at, and we should be thinking about, this is the big one. In Germany, the public support for pensions is a third of our national budget, or close to a third of our national budget.

Beckworth: Wow.

Sigl-Glöckner: And that one's going up. So if we worry about having to spend too much money, that's really where it is. So that's why I think we have to look at it, and then you asked, "Well, can fiscal policy do anything about it?" And there we think it gets really interesting, because we think the answer is yes. Because how do you tackle that issue of having to pay for expensive pensions? Well, it's people earning enough money that they can do it themselves, and that's where you get your labor market and full employment and all these things, and then we're squarely in the area of fiscal policy.

Beckworth: So it provides the means to get the economy up and running, humming at full capacity, creating the income to support the aging population. And maybe, a flip side of that, something that I've been interested in is, this demographic change really does put downward pressure on interest rates, and that's why I think, one of the key reasons in the advanced economies, you see rates getting lower and lower. The trend I think's explained in large part by this demographic aging of advanced economies. The silver lining here is that makes it easier to finance fiscal policy, right? So on one hand, demographic change creates problems, on the other hand, it creates kind of a way out by cheaper financing for fiscal policy, so it's a very interesting, I agree, very important thing. And if I had to say what's my number one concern about the US economy in the long run, it's the demographic questions. So hopefully full employment, productivity gains, all that other good stuff will help offset it.

Beckworth: Let’s jump into your paper. And again, the title of the paper is *A New Fiscal Policy for Germany*, we'll provide links to it in the show notes. You began the paper by talking about some of the big debates that we've been having, and it's been fascinating, honestly, to see what has happened in the US this past year. So just based on experience, I know you're talking about some of the academic debates as well. But what we saw in the US last year, over this past year, is we ran up the debt quite a bit, I mean, I think we doubled, close to doubling it. Maybe not doubling, but we definitely hit 100% debt to GDP ratio, which was something we haven't done since World War II, and yet, we haven't seen any changes in the financing cost, which was pretty surprising. Which suggests, at least, that fiscal space was much bigger than we thought it was coming into it.

How do you tackle that issue of having to pay for expensive pensions? Well, it's people earning enough money that they can do it themselves, and that's where you get your labor market and full employment and all these things, and then we're squarely in the area of fiscal policy.

Beckworth: And it's very similar to Japan's experience too, right? Japan has almost twice that debt to GDP, and they have really low, low rates as well. So I do think this past year, as well as the past decade, should give us pause when we think, how much fiscal space is there? Now, I'm going to be very careful here, I'm not at all suggesting we spend it recklessly, there's no guardrails in place on how we use it. But it is something that's there, and we have to acknowledge it. And there's a whole long conversation of why it's so big in the US, but it is there, and I think it's important. But you bring up, also, some of the academic debates, so I don't know if you want to speak to some of them, the r<g, what are your thoughts, what do you see happening in this debate that maybe is supportive of what you want to do with fiscal policy?

*A New Fiscal Policy for Germany*

Sigl-Glöckner: I mean, let me maybe first just make one comment on the US in the last year, because that's been unbelievable. I mean-

Beckworth: Oh yes.

Sigl-Glöckner: ... I would've never ever thought that that happens, especially under a Biden government, and probably I just didn't quite understand what he was about, but I did not think that was going to happen. And that's been, in a way, quite helpful for us, because you can show the example. It's always a bit difficult when economists speak from theory and say, "Well, people, be a bit more daring," and now just kind of let go. I can understand why people are hesitant, especially when you look at the past. But looking at the US and seeing all of this happening is a very, very interesting example for us, and it's being much-watched, actually, in Germany now.

Sigl-Glöckner: Yeah, so debt to GDP ratio has been a really big thing here. I mean, everybody was just quite sure that basically after 60% debt to GDP, something bad was going to happen. Well, we learned it didn't, because we also went beyond that now, but we also, looking at the US, and we see, as you said, there's a lot more fiscal space. We did the same experiment as you, but here people were partly really worried when we announced our big stimulus package in the spring last year, we looked at German yields, and just by coincidence on the first day they spiked a little bit, and we were like, "Well, is this fiscal space being more limited than we thought?" And then came the big drop. And I mean, it dropped hugely, -1.6, so basically record minimum. So for us the last year, looking at the US, seeing our own yields, has been mind-blowing, in a way. What we set out in the paper in terms of the academic debate, I mean, it's mainly to bring the debate that's, I think, happened in the US for quite a while now to the European and the German context. Maybe one thing that we focus on in particular, and where we try and translate the US debate to Germany is in the US you've been talking about full employment quite a lot, right?

Sigl-Glöckner: So driving the economy up to full employment, and the Fed has especially debated quite a lot what that means. We started talking about full employment in Germany, and people basically told us, "What are you talking about? We have full employment," because our unemployment rates are really, really low. And that's when we started thinking about this term, capacity utilization. The thing in Germany is, we have low unemployment, but we have a lot of people on low-wage jobs, quite few hours, so basically jobs that don't pay for a living. So we try to then take the debate from the US a step further and think about, well, what do jobs look like that are productive enough that can actually sustain a living, and hence are also good for fiscal policy? Because it we need to subsidize everybody who's working, again, it doesn't really work.

What we set out in the paper in terms of the academic debate, I mean, it's mainly to bring the debate that's, I think, happened in the US for quite a while now to the European and the German context.

Beckworth: Yeah, you mentioned yields in Germany during this period, and I have a favorite website I like to go to, the ECB has what they call the “Euro Area Yield Curve”, and they update it every day. And right now, I'm checking, so we are recording this on August 20th, and I'm looking at the webpage, it says Euro area yield curves, all the way out to 30 years, it's negative. I mean, now, this is… that 20 to 30 year sometime will go above zero, below zero, but right now it's negative which is striking, 30 years out. AAA-rated securities from the Eurozone, people are paying them to take their money. That's a very striking thing, so that does speak to something about fiscal space that you have over there, it's very striking.

Sigl-Glöckner: Yeah, exactly. I mean, as you say, we are very careful in terms of making prescriptions that work in every state of the world, because we're not sure we can do that. We're not physicists, like Arthur that you had, I think, on your last show. But in that state, financing cost is really not a worry, it's not a binding constraint. The German yield curve when you look at it is also all negative. So what we should really worry about is the future, and having enough income, then, when everybody is basically old and has long retired, and we're free to do that with the space right now.

Beckworth: Yeah, if I had to describe the advanced economies, one word or one phrase is that we're all being sucked into a zero lower bound environment. In the case of Europe, effective lower bound environment, because you're going below zero, it's negative. So the yields across the globe in advanced economies are all going negative, negative, negative, which really does put pressure on fiscal policy, right?

Sigl-Glöckner: It's interesting you say that, because I think the US case shows that it's not a necessity. Yes, you've also been very low, but actually, your interest rates and your yields have been rising, right? Which you got after a very active and expansionary fiscal policy. So actually, the textbook still kind of works. So maybe we just have a corner solution in Europe.

Beckworth: Maybe, but the 10-year Treasury's 1.25%. That's still really low, and maybe if you focus on the short end the yield curve, rates are still close to zero here in the US. Maybe a better way to state this is we're trending, the long-term trend has been going down, down, down, and I do think that puts just out of necessity more pressure on fiscal policy to deliver. And you cite in your paper this debate about what is the proper measure of fiscal space, debt capacity, and you bring up the critique that Jason Furman and Larry Summers has of debt to GDP, also Olivier Blanchard's well-known talk he gave at the American Economic Association meetings about the R being less than G, or the cost of finance being less than the growth rate of the economy, and it's tended to be that way more often than not.

Beckworth: And so that has implications that financing can go on longer. So as long as R is less than G, you can run these deficits up to a point. And you cite this one part from the Jason Furman/Larry Summers piece, which I think gets to the flavor, the spirit of our conversation, and they say, "Today's country's cannot afford to avoid pursuing fiscal policies that are expansionary," and their point is, in a world where interest rates are going down, down, down, getting to the zero lower bound environment, if fiscal policy doesn't do anything, it's actually going to lead to some kind of deflationary trap, it's going to just make things worse. By doing nothing, you're doing something, and that something is tightening policy, tightening macro policy. But doing nothing is not a response, it's passively tightening macro policy, which is a very interesting perspective to have on that.

What we should really worry about is the future, and having enough income, then, when everybody is basically old and has long retired, and we're free to do that with the space right now.

Beckworth: So with all that aside, let's talk about your three big questions. And we've touched on them, but I'll do one by one and you can respond with your solution or your policy direction you like to see the country go, Germany go. And the first one is, what is the right objective for fiscal policy? Now, you touched on it already, but tell us again, why do you think your understanding of full capacity utilization is better than this kind of cyclical stabilization view?

The Right Objective for German Fiscal Policy

Sigl-Glöckner: So I mean, especially in a world as you described it right now, where fiscal policy has to basically take on firing up the economy, we really think there's no alternative to spending money to get the economy to full capacity or full employment. And when you stabilize a trend, but that trend has been below capacity, you just keep wasting capacity. And that sounds so technocratic, but first of all it means you keep people in unemployment, which is not a happy life. And secondly, even when you talk about it from a coldhearted fiscal point of view, when you have social security and pensions to pay for, you do not really want to stabilize an economy at a below-capacity trend, and then the European Union in particular, where we didn't have such a strong recovery after the financial crisis, I think that will be really dangerous to just be complacent and say, "Well, that's enough." And if monetary policy can't do anything, well, fiscal policy is constrained, as you said, it's just not.

Beckworth: Yeah. So your argument is that Germany should pursue full capacity utilization of the economy. So run it hot, get everyone back to work, all parts of the economy just running along. What does that mean, how do you measure that, I guess is my next question. So that's the right objective, how do you know when we're there?

Sigl-Glöckner: Sure, that's kind of the million dollar question, right? So as the Fed, I think we were being hypocritical when we thought we were smarter than the Fed, we don't think you can really measure it very well. But we think we can make progress from where we are today. So today, in our fiscal policy framework, and basically all current potential output calculations, we think full capacity is reached when we are where we were in the past. So we think, "Well, maybe we can do a little better than that," and when you look at the inputs to that calculation, especially on the labor side, there's some fairly obvious improvements. In Germany, for instance, we have very, very high share of part-time employment. So then I think one obvious thing would be to get rid of involuntary part-time employment, and to say, "Well, the economy isn't at full capacity as long as there's involuntary part-time employment”, I mean, we just know these people want to work if they could, and there is space.

Sigl-Glöckner: And the same we have for participation of women in the labor force. If we have a much, much lower participation rate of women than men, we can say, "Well, probably this is a historical artifact," and rather than preserving that, basically the times women didn't really work, how about we rather look at, for instance, for us, Scandinavian countries, that have fairly similar societies, that have managed to close that gap. And that, at least, should be achieved on the track to full capacity. And then I think you have to kind of also look at it from the other side, and there I mean the US government, I think, is kind of setting an example currently, how you can do that, tracing your indicators for prices for inflation very carefully, and doing very careful labor market analysis. You can see when you get tightness in the labor market, right, if you're careful.

Beckworth: Okay. Second question you ask is, okay, how do we come up with a framework to implement this vision? So we want full capacity utilization in Germany. What is the broad framework needed to do it?

A Framework for Full Capacity Utilization

Sigl-Glöckner: Yeah. So basically, there I think we're quite lucky with the current framework we have with the debt brake in the constitution, because as I mentioned, a little bit weirdly, the constitution even includes that clause on, you're allowed to do something to make sure the economy runs at capacity. Very interesting kind of questions on interpretation of what that means and what you're allowed to do under it, but you already have that baked into our fiscal rules construct. So what we now propose to do is just to basically change how you do that calculation of how much you are allowed to spend every year in response to the state of the economy, and that you can do at the technical level, and you don't have to change the constitution. So you don't have to say to the public, "People, let go." You just say, "We're going to change how we define what a normal state, a fully-utilized economy looks like."

What we now propose to do is just to basically change how you do that calculation of how much you are allowed to spend every year in response to the state of the economy, and that you can do at the technical level, and you don't have to change the constitution.

Beckworth: Well, that's interesting. So you're saying there's already an opening in the constitution to do this, so they may not have realized what they got themselves into when they made this change to the constitution. They may have thought, "Hey, we're going to solidify our vision of austerity," and instead they made a big gaping hole for something a little more flexible. Okay, so that's the fiscal policy side of this. I just want to speak briefly, then, to the monetary policy side of this. So the ECB recently announced it's going to do a version of makeup policy, I'm not sure I know exactly what that means. I know in the US what that means is the Fed's going to keep rates lower for longer, it's going to do no harm, it's going to allow the economy to more quickly get back to full employment, restore incomes. Do you see the ECB providing the same supportive role for Germany?

Sigl-Glöckner: So I mean, I think the first and the really tricky thing is the ECB doesn't just have to cater for Germany, but also for lots of other European economies that might be at quite a different state, right? And we talked about full capacity utilization in the context of Germany, and that there is still space. But when you look at countries like Spain or Italy or Greece, it's not space, it's a massive hole, there is so much space. I mean, there have, in slightly sadder terms, over 30% of youth unemployment. These economies really, really, really need a boost. So yes, you need a central bank that's able and willing to cater for that and do that. And then it's an interesting question whether the new policy of the ECB allows for doing that. I don't think we can answer that only with respect to the policy of the ECB, and even what the ECB's been seen as doing over the last year, but the political economy of the ECB is a little bit more complicated than with the Fed, right, because the Fed has just the US government that…

Sigl-Glöckner: So, fairly clear. While with the ECB, you have European governments. And we say the ECB has strong independence, but still, there's always a legitimacy question. So I think you may have a constraint on the ECB that comes, for instance, from Germany, when people here get worried and say, "Oh, we see inflation in Germany being fairly high, because the economy is at capacity faster than other countries, or because of some transitory effects. So ECB, are you sure you want to be doing this?" But maybe that aside, just briefly on what the ECB has changed, and what they're trying to do.

We talked about full capacity utilization in the context of Germany, and that there is still space. But when you look at countries like Spain or Italy or Greece, it's not space, it's a massive hole, there is so much space. I mean, there have, in slightly sadder terms, over 30% of youth unemployment. These economies really, really, really need a boost.

Sigl-Glöckner: So the kind of big move was that they made it an explicitly symmetric target of 2%. So that means even in the short term, if we are above 2%, but we just need that to get to 2% in the medium term, they will still not tighten policy, but wait until we're solidly in that territory, medium term expectations are at 2%. And that, for the current situation, is very relevant. Because as you do, we have higher short term inflation right now, but the medium term, long term expectations are still low. So I think it really clarifies what they're doing, and kind of gives them a firmer stance to hold that policy, hold onto that stance, even if we have little spikes right now.

Beckworth: All right, very interesting. We'll need to see how the ECB does respond to these challenges moving forward. It's always been a challenge to have a one size fits all monetary policy to very, very different economies in the Eurozone. All right, so that's the framework question, we've talked about the objective for fiscal policy, the framework now. What concrete steps can we take to move Germany in this direction?

The Path to Full Capacity Utilization

Sigl-Glöckner: Yeah, so what we are proposing is really to do that change in the potential output calculation, and I mentioned three of the changes we're proposing to you earlier. So basically, instead of saying, "Hey, we just take past participation rates in the economy and say, 'This is where potential is,' we say, 'Well, how about we think about where potential could be in terms of participation rates, in terms of part-time employment,'" and then, I guess the most controversial bit, the NAIRU, so what's the minimum unemployment rate we can have, and how about we replace these three things with forward-looking best guesses of where the economy could be? And we believe you can make quite reasonable assumptions, for instance, by looking at the Scandinavian countries eliminating involuntary, part-time unemployment, or on the NAIRU, which is called NAWRU here, for some silly reason, we want to take out long term unemployment.

Sigl-Glöckner: The European definition for long-term unemployment is people who are continuously looking for work, are talking to the labor agencies to get a job, and still they don't manage to. I mean, how can you claim this is really full employment, everybody who wants to can work, if those people who've, in the long term, looked for a job, can't find one? So we want to change these three things, make these modifications, and you can do that, we think, by basically just kind of a technical modification, and kind of government manual, so you don't need a huge legal change. And that's the kind of big change we're proposing. We currently have an election coming up, and a coalition agreement that's going to be negotiated. So that might be a good time to do this. That’s the immediate first step. And then, I think, you need to look more long-term, and where is capacity really? And should we modify the debt brake even further?

We want to change these three things, make these modifications, and you can do that, we think, by basically just kind of a technical modification, and kind of government manual, so you don't need a huge legal change. And that's the kind of big change we're proposing.

Beckworth: Well, you kind of answered my next question, and that is the state of the elections in Germany. You actually see it as an opportunity to maybe get some of these changes implemented.

Sigl-Glöckner: Yes, I see it as a huge opportunity. I mean, first of all, just because of the way that German politics works, and that was one of the things that I learned at the ministry of finance, German politics is, as everything here, very, very rules-based. So we normally have a coalition government, not one party ruling, but at least two, this time it might even be three. And what they do at the beginning is they sit down and they write down a coalition agreement that everybody signs, that sets out what they want to do in the coming years. And really, everything that's in there tends to get done. Or you need to have a really good reason not to do it, it's kind of hard to block it. While when stuff is not in there, it's very, very hard to get it done. So this is really the time where policy gets made, so that's, I think, why it's a great opportunity, and then we have the same situation as you, we come out of this COVID situation, with still quite a weak economy, and basically heavily constrained fiscal space. And all parties are currently running on manifestos that you can't really translate into anything real under the current fiscal framework, so I think everybody will have an incentive to do something.

Beckworth: Okay, so you are optimistic, you can almost see the end of the race ahead of you, the finish line is coming up quickly, and you're optimistic about these proposals. On that optimistic note about fiscal policy in Germany, we have come to the end of the show. Our guest today has been Philippa Sigl-Glockner. Phillippa, thank you so much for coming on this show and for sharing your insights about Germany.

Sigl-Glöckner: Thank you very much, and thank you for doing this podcast, because it's a great source for all of us.

Beckworth: Thank you.

Photo by John Macdougall via Getty Images