Germany’s Response to the 2009 Financial Crisis

Germany deployed a 2-phase fiscal stimulus in response to the 2008-2009 global financial crisis (German GDP contracted by 2.5% in 2009), which totalled ~€82 billion (3.5% of GDP over 2009–2010). The package included corporate tax cuts, direct transfer payments to vulnerable demographics, as well as a €2,500 car scrappage premium (government incentive to replace old polluting vehicles). 

As an export-oriented economy – with exports accounting for over 40% of GDP – Germany was heavily affected by the collapse in global trade, as well as consumer and business confidence. As exports fell, and consumer/business confidence decreased, aggregate demand shifted inwards from AD1 to AD2, resulting in a decrease in average price level (PL1→PL2) and real GDP (Y1→Y2). Between mid-2007 and late 2008, GDP growth fell from an annual average of 3.5% to contraction in consecutive quarters, placing the German economy in a deep recession with a significant amount of spare capacity. 

As a result, the German government launched corporate tax cuts, direct transfer payments to parents (Kinderbonus, ~€100/child)  and low-income households, and increased wages for public sector employees. First, the significant increase in government spending (~€31 billion), led to an increase in aggregate demand, as government is a component of AD (C+I+G+X-M). Second, corporate tax cuts (reduced from 25% to 15% under the 2008 Annual Tax Act) and the lowered trade tax multiplier (from 400% to 350%), increased firms’ retained profits, increasing investment, and further increasing aggregate demand. However, it is important to acknowledge the limitations of theory: during a deep recession, tax cuts may prove ineffective due to low confidence which encourages saving over investment. 

Third, by issuing direct transfer payments to low-income/vulnerable individuals, the government’s targeted spending maximises the Keynesian multiplier effect, as such individuals have a higher marginal propensity to consume, meaning that a larger fraction of each additional euro of disposable income is spent rather than saved. In turn, aggregate demand further increased, leading to an increase in average price level and real GDP 

However, it is important to note that Germany’s strong automatic stabilisers dampens the Keynesian multiplier effect. Despite this, by targeting individuals with the highest marginal propensity to consume, the German government maximizes induced spending created by the initial government spending.

In the second phase o f the fiscal package, the German government implemented the €2,500 car scrappage premium, which stimulated domestic vehicle consumption, ultimately subsidising 2 million vehicle purchases. This scheme crucially protected one of Germany’s most vital industries, as the automotive industry accounts for ~10% of GDP and directly employs ~700,000 workers. Additionally, this measure generated an estimated €17 billion in downstream economic activity across the supply chain. 

One main flaw of the fiscal policy would be its time lag – the second package, which included the car incentive, was implemented 6 months after the initial GDP contraction. If the incentive was not subject to a time lag, it could have potentially offset the initial collapse in private consumption, preventing the depth of the contraction (GDP fell 2.2% in Q1 2009 alone) by sustaining aggregate demand. Although the fiscal response was not immediate, Germany’s strong automatic stabilizers prevented even deeper contraction: income tax revenues fell automatically (increasing households’ disposable income), while social benefits (unemployment insurance) increased without legislative delay, providing automatic demand support by preventing significant drops in consumer spending.