Germany – A Currency Manipulator?

Eckhard Wurzel

University of Konstanz

Prof. Dr. Eckhard Wurzel teaches European economics at the universities of Konstanz and Göttingen.

Hardly any economist would have disagreed if Peter Navarro, new chief trade adviser to President Trump, had just restated the standard textbook wisdom: that a common currency cannot fit well the diverging needs of economies that are hit by asymmetric shocks. But Mr. Navarro’s statement was significantly more original, claiming that Germany is using a chronically undervalued euro to boost the country’s exports and exploit its European neighbors and the United States. This view also seems to line up quite well with the proposition, expressed two weeks earlier by Trump, that the European Union is a vehicle for Germany.

So let us consider a couple of points to aid clarification.

Some Facts About European Monetary Integration

It might be useful to start by highlighting main motives behind European monetary integration.

The European Community’s endeavor to establish a system of exchange rate stabilization stretched over several decades. There was a wide-spread conviction among the governments involved that reaping the full benefits of a common European market would require getting rid as much as possible of transaction costs and uncertainties associated with (fluctuating) exchange rates. First attempts to embark on a road to European currency union date back to as early as the 1960s. At the same time, governments considered economic cooperation as an instrument to foster deeper political integration.

Eventually, under the European Exchange Rate Mechanism, the predecessor of today’s European Monetary Union, it became increasingly clear to policymakers that exchange rate stabilization and free movement of capital was not compatible with continued national monetary policy autonomy. Only two of these three features can hold at the same time, a corollary that is well known in international economics as the “Impossible Trinity.”

This understanding contributed significantly to European governments’ move to establish a common currency, the euro, and to concentrate the monetary decision power exclusively at the new European Central Bank (ECB). The move was seen by many as a major instrument to foster ever-deeper political cooperation between the European nations, a view that came to prevail in Germany as well.

This process of European monetary integration looks quite distinct from Navarro’s exploitation story. My recollection of the economic pressures and the advice that Germany and the German government, respectively, were facing when the euro was established is also quite different from what Navarro is trying to tell us.

Over most of the 1990s and well into the next decade Germany suffered anemic growth, high unemployment, significant regulatory rigidities that affected large parts of the economy, and a heavy financial burden stemming from the economics of reunification. The OECD, as well as the IMF and others, warned the German government that recovery to economic strength would require far-reaching regulatory reform in labor and product markets and the tax-transfer system. There was also a widespread belief that a weak German economy would fail to positively contribute to the economic development of other countries in Europe and elsewhere, the more so under the conditions of a common European currency.

The Dollar, the Euro, and Currency Depreciation

If all this does not match Navarro’s exploitation story, what about monetary policy? Did Germany pressure the European Central Bank into monetary expansion, in an attempt to boost the country’s exports?

The ECB, by its statute and certain institutional features, has been made independent from any interference by governments or European Union institutions. In fact, the German government did much to anchor the ECB’s independence in the Treaty on the Functioning of the European Union (as the relevant treaty was named later) and the relevant provisions on the statute of the ECB.

It is true, though, that extremely expansionary monetary policies, as observed over the last decade, were a major cause for currency depreciations and significant swings in cross-border capital flows. In response to the financial crisis, some of the world’s major central banks adopted non-conventional expansionary policies on a large scale, in an attempt to stimulate their economies out of weak growth. It was the U.S. Federal Reserve System together with the Bank of England that pioneered this approach.

Empirical work done at the Federal Reserve Bank of St. Louis suggests that announcements of asset purchase programs by the Federal Open Market Committee in 2008 and 2009 depreciated the dollar on impact relative to the euro and other major currencies by between 3.5 and 7.75 percent.[1] Empirical work done at the Federal Reserve Bank of San Francisco also found significant effects of the Fed’s monetary policy announcements on the value of the dollar,[2] as did several other studies.

While the Fed’s monetary policy caused depreciations of the dollar, calling this “currency manipulation” would be clearly misplaced. Where does the European Central Bank enter the picture? In the first phase of the financial crisis in the euro area, when inter-bank markets were drying out, the ECB successfully contributed to containing the damage in the economy’s credit system by pumping liquidity into the banking sector. Interestingly, many observers at the time considered the ECB’s monetary expansion too timid to stimulate aggregate demand, notably in comparison to the policies adopted by the U.S. Fed and the Bank of England.

However, the ECB switched strategy, embarking on massive long-term expansion of its balance sheet via asset purchases and non-conventional instruments, such as negative interest rates on its deposit facility. This was meant to push up inflation and inflationary expectations toward targeted levels. As recent research shows, the announcement of this policy was associated with strong depreciations of the euro with respect to the dollar and other currencies, compatible with the dollar exchange rate effects, found earlier, of the Fed’s interventions.[3]

This phase does not exclusively relate to the monetary policy of the ECB, though, since recent monetary policy adjustments in the U.S. added to euro depreciation. In mid-2014 the Federal Open Market Committee started signaling that it would begin normalizing the path of monetary expansion. This was followed-up by reductions in the Fed´s purchases of assets and some increase in the Fed´s policy rates. The timing of this adjustment roughly coincides with the ECB’s move toward large-scale unconventional policies. Thus, to the extent monetary policy has influenced the value of the euro, the result was also affected by diverging policy signals in the euro area and the United States.

It is no secret that the ECB’s vigorous monetary expansion is subject to much criticism in Germany. Indeed, the flip-side of super-expansionary monetary policies conducted by the Fed, the ECB, and other major central banks is that they can severely distort the allocation of capital, including capital flows across borders. At the same time, these policies are difficult to unwind—which is another finding that holds on both sides of the Atlantic.

But it is too simple to postulate a reliable link between loose monetary policies and export growth. Price competitiveness relates to the real exchange rate, which incorporates movements in domestic and foreign goods prices, rather than the nominal exchange rate which does not. If a nominal depreciation were accompanied by a proportional increase in the price of the country’s goods, the nominal depreciation would have no effect on exports. In other words, if loose monetary policy were to translate into higher inflation, the impact of nominal depreciation on trade caused by the loose monetary policy would vanish.

By the same token it would be a mistake by any policymaker to count on expansionary monetary policies to bring about higher exports. This policy would risk trading off some temporary export stimulus against medium-term inflation. Many believe that German public opinion is overly concerned with avoiding inflation risks. Is Navarro suggesting the opposite?

What About the Dynamics of Germany’s Current Account Surplus?

Germany’s overall current account surplus has reached a record high of some 8.5 percent of GDP. It is worth noting, however, that a sizeable share in German exports consists of value added that was produced abroad. International data about value added content are only published in multi-annual intervals, due to the complexity of value added chains. The last available data, released by the OECD for 2011, show, however, that the foreign value added content is substantially higher in German exports (25.5%) than in U.S. exports (15%). Also, over the preceding decade the foreign value added content in German exports increased by 72%, much faster than it did in U.S. exports (31%).

Moreover, Germany’s surplus with the countries of the euro area declined from 4.25 percent of GDP in 2007 to 2 percent in 2015. The reduction was particularly pronounced with the countries that were most severely hit by the crisis. Almost all of them eliminated their past large current account deficits and are now recording surpluses.

Some have suggested the German government should stimulate demand and imports by boosting government spending. This proposal does not look particularly convincing for an economy that appears to be operating close to full capacity utilization, exhibits government debt of 70 percent of GDP, and has a rapidly ageing society. Besides, the demand push would only be temporary, and positive spill-overs into other economies via the trade channel would be small, if visible at all.

There is scope for some regulatory reform, for example in parts of the services sector. However, it is not obvious that structural reform would reduce the current account surplus, in contrast to what is sometimes claimed. On the one hand, reform might have a positive impact on domestic demand, raising Germany’s imports. On the other hand, reform would raise the economy’s competitiveness, which would tend to provide additional impetus to German exports. Similar remarks hold for investment in infrastructure.

Perhaps the most tangible macroeconomic policy with an impact on the German current account surplus would be steps by the ECB toward monetary policy normalization. These would be appropriate anyway. Maybe Navarro only wanted to raise awareness about the ramifications of ultra-expansionary monetary policies by the U.S. Fed and the ECB. If that was the intention, I, for one, would agree.


Eckhard Wurzel teaches European Economics at the universities of Konstanz and Göttingen. He is a former Head of the Bureau for the European Union at the OECD.

[1] See C. Neely, “Unconventional monetary policy had large international effects,” Federal Reserve Bank of St. Louis, Working Paper 2010-018G, revised 2014.

[2] See R. Glick and S. Leduc, “The effects of unconventional and conventional U.S. monetary policy on the dollar,” Federal Reserve Bank of San Francisco Working Paper 2013 –11

[3] Deutsche Bundesbank, “Anleihekäufe des Eurosystems und der Wechselkurs des Euro,” Monatsbericht, January 2017.

The views expressed are those of the author(s) alone. They do not necessarily reflect the views of the American-German Institute.