Germany starts demanding first fiscal adjustments from Spain

The Covid-19 pandemic has had a tremendous impact on the Spanish economy due to the size of the worst-affected sectors – tourism in particular – and to virus-associated containment measures. When the health crisis began in the spring of 2020, the Spanish government, just like other European executives, reacted quickly by introducing measures to support workers and businesses through job-retention schemes (known in Spain as ERTEs) and liquidity lines.

Meanwhile, Brussels suspended the European Union’s common fiscal rules and the European Central Bank (ECB) approved an asset purchase program running into the billions of euros. The United States is going even further under President Joe Biden and his $1.9 trillion (€1.61 trillion) American Rescue Plan. And international organizations keep underscoring that Europe should learn the lessons of the Great Recession and avoid the temptation of phasing out stimulus measures too soon.

The EU is facing a key decision this year: whether it keeps fiscal rules on budget deficit and public debt levels on hold in 2022. The decision partly depends on the outcome of elections in Germany in September of this year, but the European Commission has already expressed support for maintaining the suspension of the Stability and Growth Pact next year.

The debate was expected to begin in the spring of 2022, but it’s already been placed on the table by several countries that want the ECB to take its foot off the accelerator. Germany, which was the main champion of austerity during the last financial crisis, is starting to talk about a re-tightening of European fiscal policy. And Spain is on its mind.

On March 1, the Organisation for Economic Cooperation and Development (OECD), which brings together the world’s most industrialized economies, began discussing the next report on the Spanish economy, due to be presented in the coming days. In a supporting document, Spain set out its macroeconomic situation – recent estimates have reduced this year’s growth forecast to 6.5% – as well as the main guidelines of its recovery plan and a list of the usual pending reforms. Germany and Greece were the main evaluators of this document, and they came up with alternative visions.

In a report from Germany to which EL PAÍS has had access, its position on Spain is that the drop in public revenue and the rollout of stimulus measures will leave Spanish public debt at around 120% of gross domestic product (GDP) for several years to come. This will leave very little room for fiscal measures when the next crisis hits, and even more so if interest rates start to go up again, as the Bundesbank is beginning to suggest.

It is absolutely premature of Germany to pressure for adjustments, there is simply no reason for it at the present moment

Jakob F. Kirkegaard, Peterson Institute for International Economics

Berlin sees an “obvious” need for a change in policy in the near future. It supports launching a pluriannual adjustment plan although the timing of it is “secondary” right now. The main thing, says Germany, is for Spain to offer “an ambitious and credible” commitment to reduce public debt, as a sign to the markets.

Yet the timing will be crucial. The International Monetary Fund (IMF) feels that economies still need stimulation, and the European Commission has spoken along the same lines. Even the ECB wants greater fiscal action for as long as the lean times continue. The first quarter has been weak across Europe, and recovery has been dragged down by problems with the vaccination rollout, by several surges in coronavirus infections, and by a delay launching the EU recovery fund.

Oblivious to all this, Berlin is already giving the first signs of what the fiscal policy debate will look like: “Depending on the evolution of the pandemic, the fiscal consolidation process should start sooner rather than later.” Germany is also warning about increased spending on pensions and its effects on Spain’s public finances.

Germany’s position has found support in the Czech Republic, according to sources who were present at the OECD meeting. Brussels instead defended that this is not the right time for adjustments, while the US delegation went even further and said it makes “no sense” to talk about fiscal consolidation when half of the eurozone is still mired in a second recession and recovery will take longer than expected.

Avoiding past mistakes

The debate is reminiscent of the one that took place after the fall of Lehman Brothers in 2008, at the time of the subprime mortgage crisis. With a recession in full swing, the world signed on wholesale to a keynesian approach to fiscal and monetary policy. But Europe did a U-turn in 2010, led by Germany and with the European Commission following in its wake. The demand for adjustments led to a series of bailouts, including one for the Spanish banking system, until Mario Draghi took charge of the ECB and pronounced his famous line about doing “whatever it takes” to save the euro during the European debt crisis. Management of the eurozone during those years of austerity overdose was “without a doubt one of the biggest mistakes in economic policy ever committed,” according to Jean Pisani-Ferry, a former advisor to French President Emmanuel Macron.

Even the most orthodox German economists fail to fully understand the rush to demand adjustments “sooner rather than later” from an economy that has been so deeply damaged by the pandemic as Spain’s has. “It would be a blunt political and economic mistake,” said Jakob F. Kirkegaard, of the Peterson Institute for International Economics. “It is absolutely premature of Germany to pressure for adjustments, there is simply no reason for it at the present moment. It would be much better to pressure for Spain to present a recovery plan with powerful reforms, and for Germany to try to present a good plan that will serve as an example of how to spend the European funds properly.”

English version by Susana Urra.