by Bill O’Grady

Since the initial Greek financial crisis in 2010, economic and financial problems in the Eurozone continue to periodically emerge.  The most recent issue is that the Eurozone may soon face deflation; price levels continue to decline.  The current yearly CPI is up a mere 0.3%.  Although the Eurozone did experience a bout of deflation in 2009 in the aftermath of the Great Financial Crisis, the current flirtation with deflation is due to weak growth in the Eurozone.

Traditional Keynesian prescriptions for deflation include expanded fiscal spending and accommodative monetary policy.  However, there is no unified fiscal policy in the Eurozone, and the European Central Bank (ECB) has an unclear mandate to execute unconventional monetary stimulus measures.  Complicating matters significantly is German opposition to both fiscal and monetary stimulus measures.

Germany’s opposition to reflation policies are usually attributed to simple national interests (Germany is a creditor nation and benefits from deflation) or due to the lingering effects of the post-WWI hyperinflation.  However, we believe that a more careful examination of the historical record suggests that the experience after WWII and the Wirtschaftswunder (economic miracle) that lasted into the early 1960s has played a larger role in shaping current German policy.

This week we discuss German history from 1946 into the late 1950s with a focus on how German leaders shaped the economy and rebuilt the nation after the war.  We will pay particular attention to the economic model that German leaders constructed and show how the Merkel government is trying to impose that model on the entire Eurozone.  As always, we will conclude with market ramifications.

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