It only took Chancellor Angela Merkel and her campaign opponent Peer Steinbrueck 19 minutes to launch into disagreement over Germany’s approach to the Eurozone crisis in a televised debate held before Germany’s September 22 general election. This was surprising. General election campaigns in Europe very rarely focus on European issues, and recent polls in Germany placed Europe sixth on the list of voter concerns behind wages, pensions, living standards, energy and taxes.
Many investors expect there to be a sea change in the German approach to the peripheral countries and to the institutional shortcomings of the Eurozone once the election is out of the way.This is partly out of belief that Chancellor Angela Merkel can take bigger risks in Germany’s approach to the crisis without elections hanging over her head. It is also because investors believe a coalition between Merkel’s Christian Democratic Union party (CDU) and the Social Democrats (SPD) would be much more euro-friendly. Both arguments are overstated.
Merkel’s approach to the eurozone crisis has been gradual, with Germany only providing concessions to debtor countries in exchange for a series of conditions. This approach has been hugely popular with voters. According to recent opinion polls, 60-70 percent of respondents believe Merkel has handled the eurozone crisis well.
There is very little appetite among the German public for bolder moves by the German government. A YouGov Deutschland poll released in early September showed that 52 percent of respondents oppose committing to further loans for Eurozone countries (versus 35 percent in favor), 57 percent opposed debt forgiveness for any peripheral countries (versus 31 percent in favor) and 56 percent did not think the next government would have the mandate to accept a joint backstop for European banks (versus 29 percent who believed it would). An overwhelming majority of respondents (around 65-70 percent) also did not think the next government would have the mandate to agree to eurobonds or fiscal transfers.
Different Plans for the Eurozone
Even without a national election hanging over her head, Merkel is unlikely to budge from her incremental approach. In a country with 16 states that comprise the upper house in parliament (the Bundesrat), there is almost always an upcoming election.
There are of course some eurozone issues on which the CDU and the SPD disagree. In a televised debate, Steinbrueck accused Merkel of creating a deadly cycle in the periphery between unsustainable debt and austerity-induced economic contraction.
He instead supports a Marshall Plan for the weaker eurozone countries to generate growth, though he provided no details on what this would entail. In general the SPD has been more skeptical of austerity and could therefore be more willing than the CDU to loosen deficit targets for the weaker eurozone countries. Still, all the major parties in Germany support fiscal consolidation at home, so it is highly unlikely any German government would agree to offer the scale of stimulus that the periphery needs to return to growth.
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The SPD is also slightly more in favor of a Debt Redemption Fund, which is a limited form of debt mutualization. The CDU has said that a Debt Redemption Fund or other forms of fiscal union could be acceptable, but only at the end of a long process of mutualizing assets and undergoing political union in the eurozone. This difference is very nuanced. While the SPD might be more open to debt mutualization on a shorter time scale, any German government will continue to prioritize protecting German taxpayers before paying for other countries’ mistakes.
Another difference between the two biggest parties is their views on a banking union. The SPD is in favor of a more comprehensive banking union that includes a Single Resolution Authority to wind down banks. The CDU, on the other hand, is more in favor of a looser banking union, with a board of National Resolution Authorities handling bank resolution. Furthermore, while Merkel has agreed to direct bank recapitalizations by the eurozone’s bailout fund – the European Stability Mechanism – as a last resort, the SPD is dead set against this. A grand coalition would most likely continue to adopt Merkel’s reluctant attitude towards a full banking union. The SPD would have little better chance of seeing its vision of a banking union achieved in a minority coalition with the Green party given that it would have to rely on support from the left-wing Linke party, which is opposed to a banking union.
A final reason there is likely to be policy continuity on the eurozone whatever the composition of the next government is that the biggest opposition parties (the SPD and Greens) have already given most of Merkel’s eurozone policies their stamp of approval. Major legislation must pass through both the Bundestag and the Bundesrat, but the current government only has a majority in the former. In the latter, there is an SPD-Green majority that has approved the German government’s policies on the eurozone.
Forced into Action
If we can’t expect major changes in Germany’s handling of the eurozone crisis after the election, what can we expect from the currency union’s largest member?
Germany will continue to do just enough to keep the eurozone from fracturing, but is unlikely to do much more. There will continue to be foot dragging on banking union, political union and fiscal union. The German government — whatever its composition — will most likely continue to offer small-scale programs for the weaker countries, such as its apprenticeship scheme and loans for small and medium companies (SMEs) (via German government development bank KfW). These policies will help on the margins, but will be a drop in the bucket compared with what is necessary to tackle soaring unemployment and difficult borrowing conditions for businesses in the periphery.
Progress on drawing a line under the eurozone crisis will be particularly slow in the absence of market pressure. While Germany calls most of the shots in the currency union, some factors could inspire market panic that are beyond Germany’s control.
Political instability is high in Greece, Portugal and Italy, and there is a risk any one of these governments could collapse. High youth unemployment and austerity fatigue after years of recession make some of the peripheral countries tinderboxes for social unrest. An announcement by the U.S. Federal Reserve that it will begin to taper its asset purchases could cause monetary conditions to tighten sharply in the periphery, choking off any hope of an economic recovery.
If any of these risks were to materialize, the German government could be forced to abandon its gradual approach to the eurozone. In a currency union that has fundamental institutional flaws, doing “just enough” will eventually have to involve bold steps towards a banking, political and fiscal union.