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German Finanzminister Peer Steinbrück is interviewed in the recent Newsweek issue, and he doesn’t sound too happy:

Doesn’t an unprecedented crisis call for unprecedented measures?
“It’s the yearning for the Great Rescue Plan. It doesn’t exist. It doesn’t exist! Dealing with an unprecedented crisis is a puzzle, a trial-and-error.”

So, what’s wrong with a little governmental push to jumpstart demand?

“Our British friends are now cutting their value-added tax. We have no idea how much of that stores will pass on to customers. Are you really going to buy a DVD player because it now costs £39.10 instead of £39.90? All this will do is raise Britain’s debt to a level that will take a whole generation to work off. The same people who would never touch deficit spending are now tossing around billions. The switch from decades of supply-side politics all the way to a crass Keynesianism is breathtaking.”

Ok, got that, Gordon Brown is a Keynes follower now. And what about Germany using its economic power to take a bold stance on this issue when talking with Sarkozy and Brown, just to make sure the both of them understand that there is no such thing as a Great Rescue Plan?

As Europe’s biggest economy and the world’s leading exporter, wouldn’t it be in Germany’s interest to take more of a leadership role in this economic crisis?
“I’m ambivalent about leadership. That Germany makes its contribution, that our capabilities are neither underestimated nor overestimated, I can live with that.”

Alright. So we know which way to go but are reluctant to tell anyone? Now wonder Germans are getting slammed for being too passive when it comes to putting a fiscal stimulus together.

Here is New York Times Columnist and freshly awarded Nobel Prize Laureate Paul Krugman explaining why Steinbrück’s talk makes him sad:

“Germany’s economy is the biggest in Europe, but even so it only accounts for about a fifth of EU GDP, and it’s only about a quarter the size of the US economy. So how much does German intransigence matter? The answer is that the nature of the crisis, combined with the high degree of European economic integration, gives Germany a special strategic role right now — and Mr. Steinbrueck is therefore doing a remarkable amount of damage.”

What’s the problem? Since European markets are highly integrated, it’s hard to target a fiscal spending program at a national economy. Krugman estimates that around 40 % of all final demand is vanishing over a country’s borders if it is in the EU. That means that the multiplier effect—the reason why governements think about spending programs in the first place—is much smaller, too.

So, a concerted action is needed. If the biggest economy in the European Union refuses to take any, it might enjoy some extra demand coming from across the border, but overall it pretty much chokes off demand in the entire EU. Which leads to a new multiplier effect, according to Krugman:

“It is, in short, a classic example of the kind of situation in which policy coordination is essential — but you won’t get coordination if policymakers in the biggest European economy refuse to go along.”

“And if Germany prevents an effective European response, this adds significantly to the severity of the global downturn.”

“In short, there’s a huge multiplier effect at work; unfortunately, what it’s doing is multiplying the impact of the current German government’s boneheadedness.”

So what does Peer Steinbrück think about the prospect of the American economy?

“The U.S. is exceedingly dynamic, has tremendous flexibility, mobility and energy, and has so far come out of every economic hole faster than we in Old Europe. There is no reason they shouldn’t come out of the current situation faster, too.”

I wonder why that is.

By Kolja