Jacob Funk Kirkegaard is a macroeconomist who resides in Brussels, following EU and other developed nations’ economies and policy makers closely. When I asked him to join me to discuss the European Central Bank’s policy decision today, President Christine Lagarde and her ECB colleagues were widely expected to do another 25bps rate cut.. After the tumultuous ground breaking press conference between President Trump and Ukraine president Volodymyr Zelensky one week ago, the German government’s resulting decision to start doing aggressive defense spending is creating shock waves and raising questions about what the ECB will do next.
To answer the bigger question of where Germany and Europe broadly head now, Jacob brings even more to the table. He has been a senior fellow with the Brussels office of the German Marshall Fund of the United States (GMF). He has also worked with the Danish Ministry of Defence, and and is a graduate of the Danish Army's Special School of Intelligence.
So sit back and hear what Jacob has to say. If this is a sea change for Europe, and perhaps the world, we all need experts like him to help us navigate.
A historic German Shift in Fiscal Policy 00:02:20.800 --> 00:02:42.999
I think the last number of days is sort of testament to the fact that there's nothing so bad that it’s not good for something and what we have seen since the disastrous White House meeting between Trump and Zelensky, is a truly historic shift in German fiscal policy… essentially, in my opinion, conservatively put a commitment to spend over a trillion euros in the next decade on a combination of defense and infrastructure public investments. that is approximately 25% of German GDP.
Higher Deficits, stronger growth 00:03:08.970 --> 00:04:00.130
It is going to lead to sustained higher deficits, but also higher growth. And as a result, certainly in the medium term, somewhat elevated debt levels, we've already seen a significant upward tick in the 10 year German Bund yield. But we've also seen comments from Standard and Poor's especially. They said that in their view this public investment oriented fiscal stimulus in Germany was actually going to be good for Germany's long term triple a rating, because, in their view, which is a view that I fully share
The Trump Bump? 00:04:00.460 --> 00:04:27.469
In light of the fact that you know capacity, utilization, and these types of things in the German economy has been going down the biggest threat to the German economy in the long run was economic stagnation, basically a continuation of the situation we have arguably had since the pandemic. What we have seen now is a very forceful fiscal policy response to that.
A call to arms; a change in fiscal rules? 00:04:27.670 --> 00:04:50.630
And this will also, in my opinion, looking at it from, you know, with your ECB eyeglasses on, there's going to be spillover to other countries you're going to see, and this will be permitted, if you like, by changes to the European fiscal rules you're going to see increased defense expenditures also in other European countries.
ECB policy will soon see a different backdrop 00:04:50.890 ->00:05:20.789
Ultimately, if you're the ECB you're looking at a situation where you know in, you know, basically, 6 months from now fiscal policy, the fiscal impulse is going to be more positive than in fact, probably without this stimulus or this defense, bazooka, whatever we choose to call it the fiscal impulse would probably have been negative in the coming years.
Clear impact on ECB’s policy path 00:05:21.180 --> 00:06:04.850
Now it's likely to be positive that, in my opinion, means that while I do not believe that the ECB is going to stop its rate cutting cycle in the near term, and by that I mean the next 2 meetings in April and June. I certainly believe that it increases the level of the ECB's terminal rate. Had you asked me 2 weeks ago, I would have said no, it would be well below 2%, because the ECB will have no choice. Well, now, fiscal policy is starting to pull its weight in Europe as well, and therefore it doesn't need to cut that much.
Germany gets substantially fiscal 00:07:19.320 --> 00:07:44.270
Well, I mean, it's certainly I do not believe that you could say that this is a one-off. As I said, the amounts are very, very large, and you know, in Germany we have a 500 billion euro infrastructure fund to run over 10 years. So, clearly, at least a medium, if not long term, fiscal expansion.
ARMS RACE! 00:07:44.420 --> 00:08:33.639
And then, on top of that, you have an essentially unlimited potential increase in defense expenditure. What this means essentially is that you have unleashed an arms race between Russia and the European Union. and that, I think, is clearly, you know, irrespective of almost irrespective. I would say of what happens in the war in Ukraine. Russia is going to be a military threat to Ukraine, to Europe for the foreseeable future. Europe is clearly has clearly signaled. There was an important speech to that as well by President Macron to the French people yesterday. and that, I think, is clearly, you know, irrespective of almost irrespective. I would say of what happens in the war in Ukraine. Russia is going to be a military threat to Ukraine, to Europe for the foreseeable future. Europe is clearly has clearly signaled. There was an important speech to that as well by President Macron to the French people yesterday.
Expect the worst from Trump 00:08:33.710 --> 00:08:52.300
The incoming German Chancellor has also said it explicitly, that we in Europe need to now expect the worst or prepare for the worst from the Trump administration. So that's what is going on. It is a long-term commitment to full European rearmament in an arms race with Russia.
Advantage: Europe over Russia 00:08:55.350 --> 00:09:15.850
The good news is that the European economy is at least 10 times arguably more the size of Russia. So this is not a race that Russia can really hope to win again in the long run, irrespective of what happens to, you know, and the battlefield in Ukraine.
A fork in the road- 00:09:16.000 --> 00:10:08.380
So what we're looking at here is a fork in the road. We're clearly led by Germany, but certainly also with a lot of other European countries, that in the last number of years have significantly been increasing their own national defense expenditures towards full European rearmament against Russia in support of Ukraine, obviously and increasingly given the frankly increasingly hostile actions taken by the Trump administration towards Ukraine. clearly with an eye of also achieving increased long term autonomy or independence from the reliance on Us. Security guarantees.
Trump gets what he wants, but not the way he wanted 00:10:41.210 --> 00:11:01.659
I certainly, for one personally, have been advocating that the European Union members and other European countries, you know, increase their defense expenditure for quite some time, because it has been clear what kind of aggressive, militaristic, imperialistic neighbor Russia is. and clearly Europe has a national self-interest. Therefore, in sustaining, supporting, promoting the Ukrainian war effort at, you know, any circumstances irrespective of what the Trump Administration might think
Could lead to the END Of NATO 00:11:01.659à 00:12:23.329
This is a good thing, and this could have led to a rebalancing of the NATO Alliance. The problem, however, is, in my opinion, that the trump administration is increasingly taking. what I can only call gratuitously and unnecessarily cruel measures that will directly hurt Ukrainian civilians, and if that continues, it's not going to be a rebalancing of the NATO Alliance. It's going to be the end of the NATO Alliance, because if the trump Administration basically pursues a policy that, as it has, I might add, in the last week or so, by actively scaling back weapons and military intelligence support for Ukraine that actively promotes Russian war efforts, it will be viewed, excuse me, as a hostile act.
A line that cannot be crossed 00:12:24.110 --> 00:13:44.090
It will be viewed, excuse me, as a hostile act across Europe against a European democracy, and if that's the case, well, then, you know the longer-term prospects for NATO are very bleak. I think it depends entirely on the continued actions of the trump administration. As I said, if the trump administration continues to pursue policies that actively weakens Ukraine's effort to resist the Russian invasion. It will lead to a shattering of NATO.
The Geopolitical Alliance Game 00:13:44.280 --> 00:14:33.290
This doesn't, however, mean at least in the short run that Europe or the EU is going to seek, you know, rebalancing by moving much closer to China, for the simple reason that of course, China also is actively, at least economically, supporting Russia's war effort as well. What it, however, will mean, in my opinion, is that this dramatically increases the likelihood that Xi Jinping might declare, well, it's maybe worth the risk of launching or escalating tension over Taiwan because there is clearly a very deep-rooted fracture in the Western Alliance.
And imagine had Europe said ‘yes’ to Trump or to Obama upping their commitments 4-8 years ago 00:14:33.450 --> 00:15:18.879
…and I would also say more broadly that while currently the actions by the Trump administration undermining potentially US commitments to NATO, forcing the Europeans to step up their defense of themselves and Ukraine against Russia. That is manageable for Europe. That's what we're seeing. The Germans are putting a lot of money on the table, others will do so. Europe has their own nuclear weapons.
Global repercussions 00:15:18.960 --> 00:15:41.379
But you know what the Asian democracies in Japan, South Korea, obviously Taiwan, Australia, etc. They don't have any nuclear weapons, and they're facing off against China, an adversary that they will not have any chance of deterring without active US support, unless, of course, these countries get their own nuclear weapons. So you know, the broader implications of these Trump administration strategies. I think, actually are going to be felt in Asia as much as in Europe.
Did Trump jolt Europe to a better policy mix? 00:20:17.670 -> 00:21:05.050
Yes, I think that's the long and the short of it. I mean the German GDP. Germany has been in recession in the last couple of years mild one, but nonetheless they haven't essentially grown real GDP. It hasn't grown since before the pandemic. So the German economy is, has had a at least a half a lost decade through, I mean through a combination of many things. You know the oil, the energy price shock, you know clearly meek fiscal response and a bunch of other things. So now we're basically, you know, putting on, or, you know, taking a very different macroeconomic direction.
Hike the German outlook 00:21:05.110 --> 00:21:50.720
And I certainly for that reason believe that we have to revise up German near term growth in both 2026 and 2027 to you know, somewhere around 2% from, you know. Arguably, maybe not zero. But say half a percent, because essentially, they have committed to spending, certainly on infrastructure, even if you assume that the 500 billion is not front loaded, that's 50 billion euros a year committed. That alone is 1% of GDP in infrastructure which typically has a fiscal multiplier above one. And then on top of that you have defense where the fiscal multiplier arguably is lower, but nonetheless certainly isn't zero so so yes, I think precisely.
Defence spending makes good neighbors 00:22:10.800 --> 00:22:47.560
You know, this was clearly part of the sort of underlying political reasons for why this happened now, namely, that Germany has had such a long period of economic stagnation, and a new government is coming in that realizes we got to do something, not only about Putin and about the national security issues. But we also got to do something to kickstart our economy. And you know there's some truth to that also in other European countries, where, as I said earlier, I certainly believe that defense expenditures will also increase.
A boost to growth 00:22:47.780 --> 00:23:33.769
But more broadly. What this does is that it puts also upward pressure, probably not a full half a percentage point, but somewhere to 0.3%, you know point 2.3% to 4-percentage point of growth on the euro for the euro area on the EU level in the next couple of years. So what it means is that the risk that the Eurozone falls into the kind of you know, deflationary spiral that happened after the double dip recession that followed the Greek and eurozone crisis in the early tents. That risk, in my opinion, is now, if not 0, then at least greatly reduced.
ECB has Confidence….but why? 00:24:03.200 --> 00:24:20.189
I think the ECB Governing Council, as well as President Lagarde at the Press Conference, was very clear. They have full confidence in their macroeconomic frameworks and their forecasts that clearly indicates that they will be back at around 2%, both on headline and on core inflation towards the end of 2025, so there's no reason for them to be worried quite frankly. And, of course, there are huge uncertainties associated with what appears to be an increasingly likely transatlantic trade war.
Europe would retaliate against reciprocal tariffs? 00:24:46.310 --> 00:24:56.159
If we assume that the trump administration implements, you know, significant what they call what they call reciprocal tariffs on April second, there's no doubt that the EU will retaliate against that forcefully. That will be a 1-off factor upward. Obviously on inflation. There'll probably be a negative confidence effect which will further depress economic activity in Europe.
Unclear forex effects 00:25:19.820 --> 00:25:43.499
We will have to see now what the exchange rate effect will be. Normally, I would have said that the exchange rate effect would be, you know, very bearish. I mean the euro would decline vis-a-vis, the dollar given the now physical. I mean this fiscal boost that Europe has got. I think that decline may not materialize.
Trade war? Bring it on! 00:27:10.630 --> 00:28:02.600
Well, look, I mean, if Donald Trump wants to have a trade war with the entire world, which is what reciprocal tariffs mean essentially, because, remember, this isn't just reciprocal tariffs. This is also differences in value, added taxes. And then any other non-tariff barrier that the trump administration identifies. If he wants to have that trade war with 85% of global GDP. He can have it. The Europeans will adapt, I believe. The Canadian approach hit back immediately and say, Look, you know, we're gonna hit back, and then, if you want to. you know, negotiate, we'll only put in the full retaliation a couple of weeks from now. I suspect other countries will do the same.
No Job bonanza for the US 00:29:41.800 --> 00:30:27.459
So this idea that the United States is on net going to attract a lot of especially manufacturing jobs back to the United States is simply a fallacy. In my opinion, it's not going to happen. There might be production coming back, but it'll be not associated with many new jobs and on net again there will be a lot of supply chains that are severed and businesses from other countries that will just have to do what Chinese companies have been forced to do for a number of years, namely, to simply ignore the Us. Market.
Trump should declare victory and move on 00:31:32.100 --> 00:31:48.169
Look. I mean, I think if Donald Trump was smart, which at some political level, I think he is, he should declare victory. You know, he should basically say, Look, I made the Europeans, you know, pony up all this money, and they're going to pay for themselves. But that's not all he's doing. He's actively helping Russia against Ukraine. That's a terrible policy.
Tariff threats ae never ending 00:32:18.160 --> 00:32:34.990
in my opinion. But I mean on this point of trump linking policy concessions on other things to the threat of tariffs. I mean, yeah. Okay. So he cut that deal with Canada, I mean, have they? Is there a material change in Canadian policy on Fentanyl. I'm pretty sure the Canadians weren't happy about Fentanyl beforehand. I know that trump said it was a huge victory a month ago that the Mexicans put another 10,000 troops, or maybe it was. I forgot it was 20,000, or whatever the number was on the border, and he declared victory. Then now, one month later, that wasn't enough all of a sudden.
Jacob Funk Kirkegaard
Jacob Funk Kirkegaard is a Senior fellow at Bruegel and a Non-resident Senior fellow with the Peterson Institute for International Economics (PIIE). From 2020 to August 2024, he was a senior fellow with the Brussels office of the German Marshall Fund of the United States (GMF). From 2013 until 2020, he was a senior fellow at PIIE, based in Washington, DC. He has also worked with the Danish Ministry of Defence, the United Nations in Iraq, and in the private financial sector.
Jacob is a graduate of the Danish Army's Special School of Intelligence and Linguistics with the rank of first lieutenant; the University of Aarhus in Aarhus, Denmark; the Columbia University in New York; and received his PhD from Johns Hopkins University, School of Advanced International Studies. He is coeditor of Transatlantic Economic Challenges in an Era of Growing Multipolarity (2012), author of The Accelerating Decline in America's High-Skilled Workforce: Implications for Immigration Policy (2007), coauthor of US Pension Reform: Lessons from Other Countries (2009) and Transforming the European Economy (2004), and assisted with Accelerating the Globalization of America: The Role for Information Technology (2006). His current research focuses on European economies and reform, transatlantic economic transition, immigration, labor markets, foreign direct investment trends and estimations, the global demographic transformation, and the impact of information technology.
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