David Milleker: Macroeconomic leverage – A way out of the financial and monetary crisis

The financial and economic crisis that has now resulted in a euro crisis has undermined truths that were thought to be self-evident. It seems that almost all self-established rules of “proper economic policy” have been broken in the last few years due to an active fiscal economic policy, tremendous bank recapi­­­­talisations, breach of the no-bail-out clause and the enormous expansion of the central banks’ balance sheets.


Social psychology calls this phenom­­enon cognitive dissonance: doing things that in fact do not correspond to the standards one has set for oneself. The macroeconomic stabilisation in the financial and monetary crisis is, without question, a case of cognitive diss­­o­­nance. It can be rationalised from a scientific point of view, whereby one clearly must admit that it raises serious questions particularly in terms of distributive fairness.

Economic rationalisation. In analysing the crises, it makes sense to refer to the basis of macroeconomics. The basic concept is double-entry bookkeeping, which represents the basis for national accounts.

Each accounting item has an offsetting entry; in economics the respective sums of production, incomes and utilisation. The logic behind this is that, for example, a company generates only as much revenue as customers spend money on its products. On the other hand, consumers only have as much income as they receive in wages and capital income (interest and dividend payments from government and companies). In brief: the income of one is always the expenditure of another.

Likewise, assets and liabilities corres­­pond to one another. One cannot exist without the other. Even something as ordinary as a banknote is a liability (in concrete terms: of the central bank to­­wards the current banknote holder). The same applies to the deposit in your cheque account (in concrete terms: of the bank towards the account holder) or for a stock (in con­­­­­­­­crete terms: of the issuing limited liability company towards the shareholder).


Realistic alternatives are limited. Double-entry bookkeeping is no means of ex­­plaining why someone behaves in a par­­ticular way (the actual meaning of eco­­nomics), but it shows that it is only pos­­­sible to achieve “good results” if different participants behave in a complementary manner to each other. If this balance sheet interaction breaks down, however – because one person wants to save money without lending money to another person, thus forcing this person to save – the economic activity comes to a halt as well. If, on the other hand, a high readiness to spend/lack of readiness to save by all participants simultaneously meets limited resources, this ultimately results in inflation.

In addition, double-entry bookkeeping also makes clear that many desirable alternatives are impossible in the first place, such as cutting expenditures while keeping the level of income or reducing debt without simultaneously reducing assets.

A specific example: if each participant cuts his or her expenditures by ten per cent, in the end everyone simply has exactly ten per cent less income without there being any change to the respective surplus and deficit items.

Stabilisation policy during the financial crisis. The rationality of stabilisation policy results from using the national balance sheet in a compensating way in case of a collapse of the balance sheet interaction in the private sector. If the private sector saves more, the state should increase its deficits. If the private sector saves less, the state should decrease its deficits.

In the course of the financial and monetary crisis, however, large amounts of assets of dubious quality were transferred to the state. This means that the stabil­­isation function went far beyond the traditional role of deficits as an absorption size for changes in the private spending behaviour.

According to the International Monetary Fund (IMF: The state of public finances: A cross-country fiscal monitor, July 30, 2009), public deficits were projected to deteriorate in 2009 relative to the economic performance in industrial countries by 5.5 percentage points compared to the starting year of 2007, two percentage points of which were attributed to economic stimulus packages and 3.5 per­­­centage points to the functioning of automatic stabilisers (lower tax income and higher expenditures due to the eco­­nomic slump). However, the same report shows 3.4 percentage points of the eco­­nomic performance for recapitalisation assistance for the banking sector, 5.3 percentage points for buying up dubious assets, 8.8 percentage points for guar­­an­­tees and 9.3 percentage points of liquid­­ity assistance via central banks. During the early stages of the financial crisis, the assistance measures for the financial sector were therefore significantly larger than classic economic stimulus packages. Public debt also rose far more than the cumulation of deficits suggests (public balance sheet ex­­tension).

Even after settlement (recovery), the Fiscal Monitor (IMF: Taking stock – a progress report on fiscal adjustment, October 2012) shows an increase of public debts for 2011 by an average of 4.9 per cent of gross domestic product through the assistance packages for the financial sector. The total for Germany equalled 10.7 per cent.

The euro crisis – double balance sheet restriction. From an economic point of view, the euro crisis is an aggravated form of balance sheet problem. First, the introduction of the common currency led to a huge movement of capital into those countries that we today call PIIGS or periphery countries. Spain, for ex­­ample, saw an increase of portfolio in­­flows from abroad (non-Spanish countries) of zero to five billion euros per month to more than 20 billion euros per month. This capital inflow initially led to low interest rates within the coun­­try and then to a building boom. Both the private sector and the overall Spanish economy (current account) became highly deficient.

At first, the course of the financial crisis showed a similar pattern: deficits moved from the private sector to the state. The second step, however, makes the situation extremely complicated; foreign coun­­tries start to withdraw capital, peaking at 20 billion euros per month.

Now the problem is that when the euro was introduced, a wide range of balan­­cing mechanisms (such as own interest rates, the exchange rate and the use of the central bank balance sheet) were abol­­ished, but no alternatives – for ex­­ample the fiscal transfer mechanism demanded by the theory of ideal currency areas – were established. In fact, it is even pro­­hib­­ited by the EU treaty via the no-bail-out clause (Article 125 of the TFEU treaty).

The basic dilemma of the euro crisis is as follows: on the debtors’ side, all na­­tional economies are deficient. This means that the state and private sector (have to) save money simultaneously. Closing the balance sheet gaps cannot be done in one’s own right due to suspended adap­­tation mechanisms. On the creditors’ side, banks try to secure their claims by early withdrawal. This, however, would directly lead to an involuntary claim waiver (default) and require renewed bank recapitalisation.

In fact, the approaches focused on providing new balance sheet instruments to give debtor nations room for an orderly adjustment and to avoid that creditors waive their claims. Bilateral credits (first Greek rescue package) were the first instrument implemented, then the EFSF and ESM were created by the governments and the central bank established the SMP and OMT.

The Target2 balances also provide an excellent illustration of the shifting of balance sheets: the early stage of the euro is marked by a considerable in­­crease in claims vis-à-vis periphery coun­­tries. The commercial banks start to withdraw in 2008. While the overall Ger­­man claims basically remain the same, Target2 claims expand at a rate of 1:1 corresponding to the withdrawal of com­­mercial banks. Claims do not disappear per se, it is the environment that changes. A private claim becomes a claim of the economy as a whole, represented by the Bundesbank (German Central Bank).

Pending questions of the market economy’s responsibility and distributive fairness. While macroeconomic stabilisa­­tion by means of various transfer operations from the private sector to public balance sheets can be justified in terms of the lesser of two evils compared to a collapse of the system, serious questions remain open. In the end, this is about the socialisation of private losses. However, the question of whether and how these can or should be transferred back to those who caused them, looms unanswered.

Milleker_IMG_3022_grossThe author studied economics in Heidel­­berg and has been chief economist at Union Investment in Frankfurt since No­­vem­­ber 2006. Before this, he worked as a research fellow at the Kronberger Kreis of liberal economists and at Allianz Dresd­­ner Economic Research, where until re­­cently he was the head of the industrial countries analysis department.