The interplay between (missing) structural reforms and monetary policy

Bachelor Thesis, 2018

67 Pages, Grade: 1,3



List of Abbreviations

List of Figures

1. Introduction

2. The choice between monetary and fiscal policy
2.1 Historical development
2.2 Evolving monetary policy and its duties
2.3 ECB - guardian of the price stability
2.4 Effectiveness and developments until the crisis

3. Imbalances in the Eurozone
3.1 A divided union
3.1 Spain’s situtation before the crisis
3.2 Germany’s situtation before the crisis
3.3 Specific imbalances between Spain and Germany

4. Monetary policy reaction to the crisis
4.1 Fixed-rate full-allotment procedure
4.2 Covered Bond Purchase Program
4.3 Security Market Programme
4.4 Outright Monetary Transactions
4.5 Asset Purchase Programme

5. Asymmetric reactions to the crisis
5.1 Reforms and measures in Spain
5.1.1 Financial market reforms
5.1.2 Fiscal measures
5.1.3 Labor market reforms
5.2 Germany’s reaction to the crisis

6. The ECB - a controversial political actor
6.1 Influencing politics in the EMU
6.2 Influencing the ECB’s decisions
6.3 Breach of the law or necessary measure ?

7. Interplay between monetary and fiscal policy
7.1 (Missing) structural reforms prior to the crisis
7.2 Lost incentives ?
7.3 Structural Reforms - a ‘convenient myth’?
7.3 Germany - driver or stability anchor in the crisis
7.4 Ways out of the crisis
7.5 Alternatives

8. Concluding remarks



Abbildung in dieser Leseprobe nicht enthalten


Figure 1: Long-Term Government Bond Yields (in%)

Figure 2 : Consumer Price Index: Harmonized Prices: Total All Items for the Euro Area

Figure 3 : House Prices, Taylor Rule and Short-Term Interest Rates (cont.)

Figure 4: Real effective exchange rate relative to the Eurozone (1999=100)

Figure 5: Net Private Savings

Figure 7: Net Foreign Assets

Figure 8: Gross Domestic Product for Spain and Germany (% change from Year ago)

Figure 9: General government gross debt for Germany and Spain (in % of GDP)

Figure 10 : Value added of construction as % of total value added

Figure 11 : Household savings (in % of household disposable income)

Figure 12 : Household debt (in % of net disposable income)

Figure 13: Growth in domestic demand (1999-2009; in %)

Figure 14: Household disposable income (Net annual growth rate in %)

Figure 15: ECB Assets

Figure 16: Foreign claims on Spain

Figure 17: Residential Property Prices for Spain

Figure 18 Harmonized Unemployment rate: Spain/Germany

Figure 19: Youth unemployment rate for Spain

Figure 20: Total Factor Productivity for Spain and Germany (Index 2000=100)

Figure 21: Long-Term Government Bond Yields for Spain and Germany

Figure 22: Short-time workers Germany (in total)


Many well-known economists argue to achieve a prospering economy; it is crucially important to have an efficient collaboration between a country’s monetary policy, concerning a stable currency and inflation rate, as well as a proper fiscal policy, including structural reforms and governmental spendings.

In the backdrop of this opinion, the European Monetary Union (EMU) was established in 1999, in which the monetary policy for several countries is centralised in one institution, the European Central Bank (ECB). This is a massive achievement, as for most of Europe’s history, it has been at war with itself, which did not foster any trade or other kinds of economic co-operation. Europe was always a continent of trade barriers, tariffs and different currencies. Therefore, doing business across borders was always highly sluggish, and in the light of all these obstacles, it tended to stifle economic growth. After World War II has left Europe in a devastating condition, the natural choice to rebuild the continent was to remove these ancient barriers. By implementing the Euro in 1999, this went even a step further. Domestic currencies ended to exist as well as the very individual monetary policies. In consequence the national central banks shifted the control to the newly formed ECB. The Eurozone had now one unified monetary policy, but still many different fiscal policies in the respective member states. Before the Euro was born, countries like Greece or Italy not only had to pay high interest rates to borrow money, they also could only lend a limited amount, as lenders were not comfortable providing them too many credits. However, as they became members of the European Monetary Union, the tables turned, because big security providers, like Germany, were now part of it.

The introduction of the euro has lowered the interest rates of the southerners to the German level, not least because a flawed regulation had created the false expectation of low investment risks. This lead to excessive private and public debt of these peripheral countries due to the low interest rates, state and private players in the future crisis countries were led to excessive borrowing. This triggered an artificial, credit-financed economic boom that drove prices and wages up much faster than in the other euro-zone countries, thus increased imports and dampened exports. The bubble burst as the capital markets refused to continue financing the enormous current account deficits that have emerged over time (EU, History; Mussler, 2011).

Today, the formerly booming countries, with their exorbitant prices and wages, are in deep structural crisis and no longer regarded as competitive players. In contrary, these countries (e.g. Greece, Italy and Spain) have all teetered on the brink of financial collapse, threatening to bring down the whole continent and the rest of the world. (Bogenberger Erklarung, 2011) For instance, Italy’s public debt is increasing steadily since the beginning of the crisis in 2007, at over 2.32 trillion €, which implies a debt to GDP ratio of over 132 per cent (Eurostat, General government debt). In contrary to that, core countries as Germany managed to lower its debt to GDP ratio to its pre-crisis level (approximately 64 per cent).

As many economists argue, the reason for this development is the partly contradictory interplay between the harmonised monetary policy and country-specific fiscal policy, in terms of structural reforms. This thesis will investigate peculiarly the antithetic progression, by giving a brief overview of monetary policy perspectives and the structure of the European Central Bank firstly. Moreover, it will concern itself with the connected fiscal policy measures and structural reforms. Thereby, two exemplary developments of Germany and Spain are provided, in order to give an insight of pre-and post-crisis conditions and measures taken by these countries. The reasons and events that peaked in this crisis will be analysed further. To conclude, some alternative approaches will be collected to answer to what extent both policies could exist and complement each other.



A sound economy is typically characterised by a low, or at best, zero output gap as well as a stable inflation rate of around 2 per cent (O. Blanchard, Dell Ariccia, & Mauro, 2010). In order to realise such a state, the question arises which combination of policy, monetary or/and fiscal, is the best approach. Herewith, a government can influence its economy either by steering the interest rate or by additional support of governmental interventions like structural reforms on the labour market or tax cuts. Generally speaking, the principal intent of the monetary policy, embodied and executed by the central banks, is to obtain a stable inflation rate correspondingly with its main instrument, the policy rate. Through the policy rate, central banks control the money supply and borrowing costs within their respective currency union and thus the economic growth. Whereas, fiscal policy can be used as an instrument to foster actions of monetary institutions or to intervene if monetary instruments are exhausted. This way of thinking was illustrated through the ancient Bretton-Woods-System. According to this, exchange rates were fixed, and countries were prohibited from implementing an own domestic monetary policy. In consequence, each state was obliged to maintain a specific exchange rate as well as a balanced current account by using fiscal policy (Holinski, Kool, & Muysken, 2012).

However, after the abolishment of this approach, the cohesiveness of monetary and fiscal policy has often been discussed controversially, and not uncommonly governments preferred a monetary approach exclusively. From an academic point of view, structural reforms were opposed as a countercyclical tool as well. Although politicians used fiscal stimulus measures frequently to tackle economic downturns, a trend towards fiscal discipline became evident. Therefore, the primary focus was on executing fiscal measures that foster debt sustainability. As a robust demographic change was (and still is) gathering in advanced economies, the politicians sought policy stances that equip their fiscal balances properly for this. To avoid boom-bust cycles, economically weaker countries acted to evade default crisis as well as policies that would restrain procyclical fiscal policies. From a fiscal point of view, only "automatic stabilisers (were) left to play" (Blanchard et al., 2010, p. 6). Automatic stabilisers, like taxes on corporates or labour, are used to counteract variations in a nation's economic activity without any governmental interference. Admittedly, with the expansion of the government's contribution to the output, automatic stabilisers played a more significant role (Blanchard et al., 2010)

Blanchard et al. (2010) examined the interplay between both policies and cited five reasons that led to this reluctant attitude towards fiscal measures in favour of the monetary policy in the past. Firstly, according to the so-called and highly popular Ricardian Regime, monetary policy is regarded as the only real political tool to steer the economy properly, since the effectiveness of fiscal policy was sceptically considered. According to the advocates of this theory, fiscal expansion does not increase private consumption, once consumers anticipate the future actions of governments. Secondly, there was no need to adopt other approaches, as long as monetary policy managed to maintain a stable output gap. Thirdly, the rapidly advancing developments in the financial markets can be seen as drivers of an increasingly effective monetary policy, which further contributed to the declining popularity of fiscal measurements. In addition, there was no relevance to use structural reforms, since core countries (a commonly used term for advanced economies like Germany), in particular, were mainly focused on the stabilisation as well as the reduction of their typically high debt levels. On the other hand, peripheral nations lacked an advanced domestic bond market which bounded the scope for countercyclical fiscal measures anyway. Fourth, because fiscal policies are usually associated with lengthy and complicated decision-making, their effects take hold too late. And fifth, concerning the arguments mentioned before, the impact of these decisions is often furtherly limited by political constraints and compromises (Blanchard et al., 2010).


In the backlight of the heavy overweight in favour of a monetary-focused policy in the past, the following part depicts briefly how the significant responsibilities of central banks have evolved over the last centuries as well as the main principles of the ECB. Generally speaking, the common understanding or rather interpretation regarding the duties of monetary policy have evolved over the past decades significantly, always depending on the current economic situation. Herewith, a set of essential scientific beliefs, derived from theory and empirical proof, guided thinking at central banks from the early beginnings until today.

In the early years, a central bank was seen as a ‘lender-of-last-resort’, that should take actions if markets were lacking liquidity. In this context, the Federal Reserve (Fed) was established, in order to „prevent financial panics“ (Cukierman, 2013, p. 2)as well as unsustainable inflation rate movements (Cukierman, 2013). Subsequently to the Great Depression, the central bank’s focus changed to a broader view, namely preserving a stable economy. Herewith, the economist Phillips developed a model-approach in 1958, the so-called Phillips- Curve, that claimed an inevitable tradeoff between inflation and unemployment, which must be carried out to create a vital economy. This emerged in a variety of possible measures, both from a monetary and fiscal point of view (Samuelson & Solow, 1960). Following the high inflation levels in the 70s, the broad consensus modified in a way, that the central bank's foremost obligation is to ensure price stability (Cukierman, 2013).

After the years of moderation, which lasted from the 1980s until the collapse of the subprime bubble in 2008, monetary policy was regarded as a tool to stabilise real business cycles in the short and medium run too. Thereby, inflation was now allowed to deviate slightly in the short- and medium-term from his target, which was then entitled as „Inflation Targeting“. Taylor converted and refined this view into the famous Taylor rule, which recommended central banks to value their interest rates depending on divergences from the predefined output and inflation targets. As long as the central bank manages to achieve the target of inflation and output gap, there is no need for other measurements or so-called unconventional measures (Cukierman, 2013).

Cukierman (2013) describes four observations which represent the persuasion regarding monetary policy prior to the crisis in 2008. Firstly, he states, complying with the Ricardian regime, „the (real) interest rate the main policy instrument [...]“ (Cukierman, 2013, p. 2). Secondly, he suggests that central banks should operate against upcoming bubbles and prevent inflation from rising too strong. Third, against the backdrop of ‘Inflation Targeting’, „financial stability and prudential considerations took a back seat “(Cukierman, 2013, p. 2), which means that central banks focused solely on achieving their announced inflation target instead of paying attention to fiscal indicators or regulatory actions. This statement is complying with Blanchard et al. ‘s (2010) statement mentioned above of the fiscal policy’s secondary role. In connection with this restricted approach, systematic financial risks were mostly disregarded as well. Fourthly, as long as monetary policy manages to keep the economy in stable conditions, there is no need to waste a thought about implementing alternative measures. However, it becomes evident that if in a crisis the zero lower bound takes effect, the central bank lacks options, as the interest rate cannot be below zero. Hence, other measures are required to get the economy back on track, which both, the European and US-American economies, have encountered during the global financial crisis (Cukierman, 2013).

Before describing the developments and interactions between the two policy stances, it is crucially important to become acquainted with the situation prior to the crisis. The next section will describe the European Central Bank (ECB), its principles, the main instruments and policy stance until the outburst of the financial crisis in 2008.


The implementation of a common currency was regarded as the „final step in the European economic and monetary integration process“ (Holinski et al., 2012, p. 1). In consequence of the introduction of the Euro among initially 11 European states, the ECB was granted the responsibility for the monetary policy in the whole Eurozone. Thus, the ECB acted as a centralised institution, taking full control over the monetary policies of all euro-area countries. Like the ECB states on its website: its „primary objective [...] is to maintain price stability (by remaining the) inflation rates of below, but close to, 2 per cent over the medium term. “(ECB, 2018). In doing so, the ECB is much more conservative than other central banks, e.g. the Fed (Cukierman, 2013). While price stability is the top priority goal of the ECB, the Fed is supposed „to increase production, to promote the goals of maximum employment effectively, stable prices, and moderate long-term interest rates” (Fed, Monetary policy objectives). Moreover, the difference becomes clear by comparing the respective reactions of both central banks. (please refer to Part 4).

Stark (2009), a former Member of the ECB’s executive board, exemplified the institution's guideline to obtain price stability. The ECB relies on a „two-pillar-structure “which takes both, an economical as well as a monetary analysis into account. In doing so, the economical part considers indicators, such as wages and price indices, to identify striking short- and medium-run dangers to the price stability, whereas the monetary analysis focuses on the inter­coherence between money and prices.

Amongst others, the policy rate is regarded as the ECB’s main conventional instrument. By regulating this rate, the ECB has an indirect influence on banks' lending behaviour, since it represents the borrowing costs at which commercial banks can refinance themselves. Precisely, this refinancing tool is defined by two maturities for direct lending to banks against eligible collateral. First, main refinancing operations (MROs) and Longer-term refinancing operations (LTROs), which have a duration of two weeks and three months respectively. In usual times, MROs and LTROs are auctioned by the ECB at a predetermined volume and price (Fawley & Neely, 2013). Commercial banks lend the central bank money to other banks, but at higher interest rates. Change in cost structures is reflected ultimately on the conditions of private borrowers again. This is referred to as the interbank market. Hence, if the ECB increases or decreases the policy rate in the short term; it manipulates the credit costs banks demand from private clients and thus the economic growth. However, the ECB grants commercial banks a loan, only if these can guarantee sufficient collateral. This is intended to shield the Euro system against damages arising from its monetary policy operations since banks could lend, theoretical, infinite amounts of money otherwise (Bednarek, Dinger, & Westernhagen, 2016).


To examine the success of the ECB’s policy, a look on the numbers is reasonable. As a consequence of the new common currency, the interest rates of the respective countries were approaching remarkably. By doing so, peripheral nations, also commonly referred to as PIIGS states (Portugal, Italy, Ireland, Greece and Spain), were now capable of refinancing themselves roughly at the same cost as the wealthier states. Lenders assumed that bonds of every member state of the European Monetary Union were evenly safe and thus, refinancing rates for bonds issued by peripheral countries and core countries, like Germany, did not differ significantly (Beker, 2013). This becomes evident by looking at Figure 1, where interest rates of PIIGS countries converged towards Germany's interest rate. For instance, by January 1999, the time when Spain joined the monetary union, yields on Spanish 10-year treasury bonds had fallen under 4 per cent from well beyond 12 per cent in 1995. By contemplating the period between the launch of the euro and the time shortly before the crisis, this development was regarded as expedient, since the ECB succeeded to obtain its overall inflation target of around 2 per cent for the eurozone (Figure 2). Admittedly, the set interest rates were only slightly under the appropriate Taylor rule-recommendation during this period but were well below for some other member countries. Figure 3 shows that during 1998 and 2005, Spain’s interest rate was well beneath the recommended rate according to the Taylor rule. Moreover, by analysing Figure 4, which illustrates the real exchange rates, it becomes evident that the inflation levels and thus the economic situation differed vastly between the EMU members.

Again, as aforementioned, the ECB is responsible for the monetary policy over the entire eurozone, which implies a single policy for partly highly distinctive countries. The fiscal decisions were still made independently in the respective countries themselves. In this context, the member states signed the Stability and Growth Pact (SGP), which set binding constraints on each member's fiscal policy to prevent these from heading in potentially problematic directions. In order to address this danger, the SGP limit the annual budget deficit at 3 per cent of GDP and the stock of public debt at 60 per cent of GDP (Bundesbank, Stability and Growth Pact). Additionally, a no-bailout clause (Article 125 of the Lisbon Treaty) for member states who do not meet their debt obligations, has been established. Hence, as both, fiscal and monetary policy, appeared to be appropriately addressed, the broad consensus was that this would ensure sustainable growth and economic convergence in the euro area. Nevertheless, the reality, especially considering the estimated convergence, looked different, but policymakers ignored that. (Holinski et al., 2012)

The impact of this discrepancy will be scrutinised in the following parts.


The impact, repercussions and distinct developments in the euro area, triggered by policy measures, both monetary as well as fiscal nature, before the eruption of the financial crisis will be studied furtherly. Herewith I give a brief overview of the situation in the euro-zone in general as well as deep dives into two diverse countries, namely Spain as a representative of a periphery country and Germany, as representative of the core countries.

To understand the events surrounding the euro crisis as well as the responses of the political and monetary side, a look at the pre-crisis conditions is inevitable. Following the abolishment of the Bretton-Woods-System, exchange rates became flexible. In combination with an evolving financial market, current account divergencies were given only a little consideration thenceforward (Holinski et al., 2012). Quite in contrary, imbalances were deemed as „signs of the proper functioning [...] “(Ahearne, Schmitz, & Von Hagen, 2009, p. 15), financial markets, since it improves the allocation of capital across countries. According to this so- called convergence process, financial integration causes money to flow to countries with relatively low per capita income because investors believe in greater returns there. Subsequently, productivity growth must be carried out as it is intended to assure the repayment of the invested capital. Meanwhile, the respective countries consume more and save less, and the resulting current account deficits are nothing to worry about (Holinski et al., 2012). If and in how far this convergence process took place will be analysed in the following section.


The EMU can be divided into two parts. First, the northern states, who are pursuing an export-driven strategy, which is determined above all by competitive advantages. These countries depend on global demand to boost their economy. This strategy rejects expansionary policies, as these would lead to increasing wages, which would consequently imperil the competitiveness of their exports (Hall, 2012). Furthermore, especially countries like Germany were huge supporters of balanced governmental households and sustainable management. Secondly, the southern part of Europe is determined by a demand-driven economy. These countries navigated their fiscal policy to foster their domestic demand. As a result of the common currency, it was no longer possible to depreciate exchange rates against their main trading partners, resulting in „some perverse effects “(Hall, 2012, p. 360). Since the southern countries obeyed the promotion of domestic demand, inflation rates were comparatively higher than in the north. Consequently, unit labour costs progressed (Hall, 2012) Ironically, this was additionally backed by the EMU itself. As outlined in Part 2 the ECB sustains a joint monetary policy for all member states and thus were not willing to overcome inflation in the periphery, as it could hurt the extension in the core countries. In result, inflation rose further, therefore diminishing the south‘s borrowing even more. Meanwhile, the northern nations produced sizeable current account excesses, which in turn was entrusted through investments and credits to the demand striving south, cherishing consumption again. One could argue, the praised convergence process within the heterogeneous union has not occurred. The reasoning following these occurrences and precise, in-depth looks is summarised in the next section (Hall, 2014).

Blanchard and Giavazzi (2002) argue that financial integration had a considerable impact on both, core and periphery economies in the aftermath of the EMU‘s birth. As previously mentioned, one of the consequences regarding the new currency union was that periphery countries, like Spain, had now full access to the global financial markets and was capable of borrowing money on equivalent terms as Germany. Furthermore, regulations were abolished, which formerly impeded capital to flow freely between the European countries with remarkable impacts on the behaviour of investors and the capital movements within the eurozone.

Blanchard and Giavazzi (2002) analysed savings and investment distinctions explicitly and determined an exceptional imbalance between both back then. Apparently, in the light of low- interest rates and attractive credit constraints, the incentive to save money was no longer given for people in the periphery. Hence, their consumption increased and thus reduced their savings. This development becomes evident by looking at Figure 5, where a marked drop in net private saving is observable for southern countries. Herewith, it is crucial to distinguish between public and private savings. Even though, the numbers prove that member states implemented policies to promote fiscal consolidation, while individual agents could not be controlled (Figure 5, 6). Contributing to this, foreign investors from core-countries were seeking higher return rates and expected the growth opportunities in the periphery to be promising. By granting these countries credits and direct investments, their domestic consumption heightened since the economy grew faster and wages increased (Eichengreen, 2010). Thereby, saving in core-countries extended and investment faded (Blanchard, 2002). In this context, Ahearne, Schmitz, and Von Hagen (2009) affirmed an extraordinary drift of intra-euro-area capital flow from high- to low per capita income countries in the euro-zone. Figure 7, where net foreign assets emerged in opposite directions, beginning with the euro advent, supports this bias. Nonetheless, according to Ahearne et al. (2009), the shared currency appears to be the driver, as this unidirectional stream of money is not discernible between euro-area countries and the rest of the world.

Later, Holinski et al. (2012) verified this development in a comprehensive analysis and presented comparable outcomes (Quelle). Herewith, they distinguished between northern (Germany, Netherlands etc.) and southern (PIIGS) nations within the eurozone. Generally, the euro zone's current account has been more or less balanced unto 2007. However, they ascertained a vast divergence between northern and southern countries, too. Evidently, this can be perceived as consistent with the stable inflation rate in the Eurozone as a whole, but similar deviations among respective nations. While the north experienced a progressive growth of its current account surplus from 1994 to 2006, the contrary is valid for the southern members. After a nearly balanced current account for southern countries, the deficit expanded to almost 7 per cent of the consolidated GDP from 1999 with the introduction of the common currency onwards.

With respect to the diverse economic strategies, a more pronounced asymmetry becomes apparent, namely that of competitiveness. This divergence occurs by comparing productivity and compensation level growth between the north and south. While compensation payments developed disproportionately in contrast to the north, there was no comparable gain regarding southern productivity (please refer to data in Part 3.3) (Ahearne et al., 2009). The reason for this, apart from the steadily soaring real exchange rates and the associated rising wages and prices are the fundamentally different structures of the labour markets. Once again, the EMU can be divided into two separate bearings. While unions in the north could react much more flexible and consciously to new market conditions, the southern industry suffered from rigid and centralised labour laws. The resulting excessively growing wages in relation to productivity further fueled a competitive disadvantage of the southern parts of the continent (Boltho & Carlin, 2013)

A closer look, including data for Germany and Spain is provided in Part 3.

In the backdrop, it becomes evident, that due to the mentioned developments of cheap credit conditions and inflow of capital, reduced the pressure for peripheral countries to implement reforms to improve competitiveness imbalances, since governments could easily refund their current account deficits with the inflowing capital from abroad (Moro, 2014). This cannot be addressed directly to the ECB, as it was also the financial markets that mispriced the risk. In fact, the ECB opposed changes that would have watered down the SGP and already warned of the continuing loss of competitiveness of some Eurozone countries before the crisis and advocated a stricter implementation of fiscal surveillance. However, during the pre-crisis years, no incentives were set to reduce debt (Moro, 2014). Thereby, Benetrix and Lane (2012) confirm that fiscal policy became less countercyclical in the aftermath of the euro’s advent.

Subsequently to the previous, broader statements follow a deeper analysis of Spain’s and Germanys economical situations. After a summary concerning the general circumstances, this thesis will provide specific data that supports, defines and expands the points mentioned above.


The following section will give a summary of the general circumstances in Spain before the crisis.

Spain joined the Eurozone as one of the first countries and well-developing members of the EMU, in January 1999. Due to annual migration rates between 1 million (2010) and over 2.8 million in 2002, consequently, Spain’s population continually expanded from just above 40 million, reaching its peak at approximately 47 million in 2012. Even though Spain created one-third of all new jobs in the European Union between 1999 and 2007, low paying jobs assigned the most of it, probably a result of the influx of immigrants, willing to work for smaller wages (Banco de Espana, 2017). Spain's political landscape had been shaped between 1996 and 2004 by the ruling party’s economic-liberal course. In the course of the Madrid attacks in 2004, the social democrat Zapatero gained power in the Spanish parliament, who guided Spain through the beginnings of the euro crisis. By examining the overall economic development in Spain, it appears that political measures were effective, as the country experienced a steady extension from 2000 until the financial crisis in 2008 (Figure 8). Considering the SGP mentioned earlier, Spain followed the fiscal restrictions and reduced its public debt until 2007 gradually (Figure 9). Following the tendency of high investments in the peripheral countries, it is essential to state that most of the inflow capital went into the real estate sector. This becomes evident in Figure 10, which illustrates the construction sector‘s value-add to the economy. While the Eurozone area grew only slightly from about 5.5 per cent to 6.5 per cent between 2000 and 2009, Spain’s level skyrocketed in the same period from below 9 per cent to its peak in 2008 at over 12 per cent. Moreover, the construction sector contributed approximately 17 per cent to annual GDP (Etxezarreta, Navarro, Ribera, & Soldevila, 2012). In association with gradually declining interest rates for mortgage loans (dropped 9 per cent since the early 90s), real estate prices inflated continuously at an average rate of 8 per cent between 1997 and 2007 (Lin & Treichel, 2012). Unsurprisingly, the homeownership rate in Spain marked at over 80 per cent in 2011 compared to a rate of about 50 per cent in Germany (Trading Economics). The financial deregulation supported the conception of risky derivatives, like mortgage-backed securitisation and asset-based securitisation, whose real risk was not adequately evaluated. In combination with a poorly supervised banking system, Lin and Treichel (2012) claim that this trend had a significant impact on Spain's real estate market. Overall the Spanish economy experienced a remarkable boom phase prior to the crisis, however characterised by an overweighing real estate sector and dependence on foreign capital.


The following section will provide a brief history of Germany before the financial crisis. In contrast to Spain, the economic development in Germany was not that bright. In the course, the well-known nickname "the sick man of Europe" was used more and more frequently (The Economist, 1999). A look at the history books helps to understand how Germany came to this inglorious name. First of all, the fall of the Berlin Wall and the subsequent reunification brought enormous costs for the German state and taxpayers. Sluggish growth and high unemployment marked the 1990s and early 2000s (Dustmann, Fitzenberger, Schonberg, & Spitz-Oener, 2014). As shown in Figure 8, between 1998 and 2005 Germany grew only at 1 per cent on average. Furthermore, unemployment swelled from about 9 per cent in 1998 to more than 11 per cent in 2005 (Dustmann et al., 2014). As mentioned earlier, the Spanish government managed to reduce its debt by nearly 25 per cent until 2007, thus meeting the SGP criteria without any difficulties. By contrast, Germany's debt expanded by approx. 10 per cent in the same period. Recalling the export-driven economy, this may be attributed to the bursting of the dotcom bubble and the concomitant economic downturn (Bundestag, 2009). Politically, Germany was led by Helmut Kohl, who brought Germany the reunification, and Gerhard Schroder who took over in 1998. He executed, in consequence of the miserable economic situation, the Agenda 2010 or Hartz reforms. Among other things, these provided for more flexible structures in the labour market (e.g. lower target achievement and more liberal dismissal regulations) and were supposed to reduce unemployment (Walwei, 2017). Indeed, the unemployment rate fell by 3.5 per cent until 2010, and one could argue that the reason for Germany’s little damage of the financial crisis was rooted in this reforms. However, Dustmann et al. (2014) say that „the specific governance structure of the German labour market institution^ (Dustmann et al., 2014, p. 168)was the primary reason for its positive development after the crisis. While the Spanish labour market is rooted in legislation, the German model is based on free collective bargaining that provides flexibility. In contrast to peripheral countries, the German economy is export-orientated and accordingly rejects expansionary fiscal policy, since wages would otherwise increase and inhibit exports. Also, in comparison to peripheral countries, the German labour law is characterised by the German labour union system. With such an arrangement the German economy always had greater flexibility to react to the labour market situations effectively at any time. This feature will support the following data regarding imbalances between Spain and Germany (Dustmann et al., 2014).


In the following section several indicators will be given to outline the different developments between Spain as a peripheral and Germany as a core country.

As mentioned above, the implementation of the euro led to approaching interest rates among the countries and fewer incentives to save money in the periphery. Figure 11 outlines the propensity to save for Germany and Spain in the years before the crisis. While German households consistently saved between 9 and 10 per cent of their income, the value for Spanish households plummeted since 2002, reaching its low in 2007, at almost minus 1 per cent. As can be seen from the chart, this development is also much stronger compared to the entire Eurozone.

Correspondingly to the lower saving rates, household debt to GDP skyrocketed in the same time, reaching its peak at 150 per cent for Spanish households, while the Germans managed to decline this ratio by over 10 per cent, leaving them at 100 per cent in 2008 (Figure 12). This sharp increase in consumer lending was mainly channeled mortgages for houses, since the real estate sector experienced a vast boom. (please refer to 3.1).

Spain‘s domestic demand increased significantly by over 30 per cent between 1999 and 2009, which was the second highest rise after Greece. In contrast, Germany’s domestic demand proportion to GDP increased only slighlty at beneath 5 per cent (Figure 13). As a result, Spains GDP per capita experienced an enourmous increase of more than 11 indexpoints between 1998 and 2008, in relation Germany, who represents the benchmark in Giavazzi & Spaventa’s (2010) calculations. Pure data from the Worldbank, supports their evaluation: the annual growth rates of household incomes in the pre-crisis years, shows that Spanish households have always outperformed the German ones, with the particularly extreme difference of over 3.5 per cent in 2008 (Figure 14).

Yet this approach of per capita income happened in combination with a tiny rise in labour productivity (Giavazzi & Spaventa, 2010, Table 3). Holinski et al. (2012) support this statement in their analysis, as they found a clear lowering trend in the southern countries in comparison to the northern ones (Holinski et al., 2012, Figure 13). By looking at the actual unit labour costs (ULC) change over the years before the crisis, it becomes apparent that an enormous divergence can be found between German and Spanish workers. While Spains relative ULC increased by 27 per cent between 2001 and 2011, according to Dadush (2010), a contrary trend can be seen for Germany, where ULC rose only by marginal 0.9 per cent. Herewith, a look on Germany’s backbone of the economy, the manufacturing sector is reasonable to support the competitive divergence. While about 21 per cent of all jobs were in this sector in 1995, it contributed more than 22 per cent to the German GDP. Whereas in 2007, the level of contribution remained roughly equal, but only 18 per cent worked in the manufacturing sector (Dustmann et al., 2014).

The remarkable increase in per capita income in combination with the rising ULC and stagnating productivity, underlines the huge problem of competetive asymmetry between Spain and Germany. To let these figures approach to each other will be one of the main arguments subsequently to the crisis, in order to overcome the crisis. This question will be furtherly examined in Part 7.


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The interplay between (missing) structural reforms and monetary policy
University of Frankfurt (Main)  (House of Finance)
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Monetary Policy, Euro-Crisis, Structural Reforms, Economics, Austerity, European Monetary Union, Zero Lower Bound, ECB, Fiscal Policy
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Philipp Huber (Author), 2018, The interplay between (missing) structural reforms and monetary policy, Munich, GRIN Verlag,


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Title: The interplay between (missing) structural reforms and monetary policy

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