MNI INTERVIEW: ECB Rates Already Too High - Bofinger

The European Central Bank’s decision last week to hike rates likely leaves Europe trapped with too-tight monetary policy for the next six months, a leading German economist told MNI.

While its impact on the pace of price growth will be limited, the 25-basis-point hike to 2.25% was “really designed to send a psychological signal after they reacted too late to the crisis following the Russian invasion of Ukraine,” he said.

“The correct response would have been to allow fiscal policy to soften the shock and limit its impact directly, as it has been trying to do in Spain, for example, with the reduction of VAT, and to a lesser extent in Germany with the gasoline rebate,” former German Council of Economic Experts member Peter Bofinger said in an interview, calling higher interest rates “a blunt tool.”

The ECB is now likely to fall behind the curve in cutting rates, since such a “huge U-turn” would be to admit it made a mistake, “albeit one that did not do anything to bring down inflation,” Bofinger said. 

“The ECB will wait a while before lowering interest rates even if inflation does start to come down rapidly - at least two quarters or so," he said, adding that while the central bank claims 'data-dependent' does not mean data-point-dependent, "it means always waiting, which means you are naturally behind the curve - especially when things are changing rapidly.” (See MNI SOURCES: ECB September Meeting 'Live' Despite Iran Deal)

GERMAN ECONOMY

While the Bundesbank projects that expansionary fiscal policy, particularly from defence spending, will contribute 1.3 percentage points of Germany’s GDP growth from 2026-28, Bofinger said the economy’s main problem remains a lack of private investment.

“So far, we’ve not seen much impact from the government’s economic policy, especially on private investment, which is very weak. Our whole economic policy lacks a strategy; worse, policymakers do not even realise that a strategy is needed,” he said, calling for government, scientific experts and companies to identify the main areas in which Germany can compete strongly in five to 10 years’ time. 

“But that is absolutely lacking. Yes, we need less bureaucracy, etcetera, but this microeconomic approach will not succeed,” Bofinger said.

New government incentives which allow companies to offset a greater share of recently-acquired assets as depreciation will be ineffective, Bofinger said, adding that they will also depress tax revenues for the next five years.

“It does not mean that companies will invest more, only that they can continue to invest at the current level. Nor do they have to invest more to qualify for it. If that’s the main instrument, it’s not surprising that companies aren’t investing more in Germany.”

Large German firms are laying off workers - an indicator, Bofinger said, that they do not see production as being limited by a lack of skilled workers, as was the case five years ago, but rather as due to insufficient demand. “Nor do I see how that can be stopped without a change in our business model,” he said.

NO TO PROTECTIONISM

Germany’s reliance on Chinese solar panels and batteries for its energy transformation means it cannot afford to be protectionist, Bofinger said. Instead, it should look to copy China’s own tactic of technological “leap-frogging,”  by identifying areas, such as renewable energy, where it can use Chinese products to gain a competitive advantage, while encouraging Chinese companies to build factories in Germany and Europe. (See MNI: EU Action On China Would Cut Off Key Supplies - Advisor)

Bofinger, a member of the special commission that will report later this month on potential pension reforms, said it is “very difficult” to make major savings, with public payouts already lowered in recent years and any further reduction likely to test the legitimacy of the entire scheme.

“Nor do I see that you can save a lot with the health system. Of course, there is a commission which has made certain recommendations, but I doubt that the savings it proposes will be sufficient to fundamentally change the state of our public finances,” he said.

“That is in any case not the main problem right now. It’s our business model. Fix that, and we will be able to deal with the public finances.”