Did Merkel really change her mind?

After World War I, defeated Germany almost simultaneously faced two very serious economic disasters: galloping inflation and an unexpected recession. As the first problem has been remembered well mainly because of fantastic inflation figures which have never been observed before or since the 1920s, still very few professionals have been paying attention to the second disaster. As a result, most of the comments on the immediate rise of Hitler generally point to the political preference change of the simple German people who suffered most because of unbelievable increases in the prices of basic goods.

However the “few professionals” mentioned above insist that the recession also played an important role in why people believed the job and wealth promises of the new political elite. As a matter of fact an important part of those promises were realized and this became the main reason for the further increase in Hitler’s popular support. The remaining part of the story, as everybody knows, the unrealistic dream of Germania and World War II, which did more harm than inflation and recession to the German people and, of course, to the rest of the world.

It might be interesting to remember the content of Keynes’ letter to Britain’s prime minister carrying his resignation from his job in the British delegation during the Versailles WWI peace treaty discussions. Then he was a young and simple bureaucrat, and of course not yet famous. That letter might be considered a sign of his megalomania, but also has shown his ability to predict the future. He was against the heavy war reparations burdened on Germany. He insisted in his letter that, without mentioning the inflation risk, this huge amount of reparations would push Germany, and maybe all Europe, into a serious recession. After a short time it has been proved that he was right.

Since the last EU summit it was generally believed that the unhappy memories of the historical German inflation made Chancellor Angela Merkel hesitant till the last moment to approve the policies defended by the majority of eurozone members. There were some comments that at last she had changed her mind. If those comments were true, did she think that a probable recession and rise in unemployment also in her native country might create a more serious political risk for herself than an unexpected inflation surge which might be originated because of loose monetary and fiscal policies? It is of course impossible to read her mind; one can only make some assumption about why her popularity increased immediately after that summit, in contrast to the common belief in Europe.

A similar discussion is going on in the United States. Some economists think that U.S. economic policy was paralyzed because of again historic debt-deficit-inflation fears. The economic policies implemented by various administrations after WWII can be classified as two different approaches. The first one was the common approach until the 1960s, which might be defined as low inflation and balanced budgets. The second approach, which was first implemented by the Kennedy administration, was modest deficit-modest inflation-reasonable growth and job creation.

However, as history proved several times, the second approach quickly derails macroeconomic balances. Modest deficits become huge, then modest inflation becomes galloping, and finally reasonable growth and job creation turn into stagnation. Huge deficits form a trap for the governments or administrations such as the inability of using loose monetary and fiscal policies further in order to stimulate the economy. This might be the situation in the U.S., in spite of coming elections and in spite of modest inflation.

One last note: Chancellor Merkel has been seen at first as a big loser after the eurozone summit last month. However, as mentioned above, her popularity among the German people increased immediately after the summit, in contrast with the common belief in other parts of Europe. Maybe the simple people in Germany can read the chancellor’s mind more easily than other Europeans. Could Moody’s recent downgrading of its outlook on Germany’s triple-A rating weaken the chancellor’s popularity? Probably not.