This paper describes four features of the German economy which lie at the root of its external imbalances: the evolution of its real exchange rate; the underlying trends in productivity and unit labour costs; the persistent shortfall of investment relative to domestic savings; and the deployment of much of the current external surplus in portfolio investments outside the euro area.

The euro has helped Germany maintain a strong competitive position for its exports within the euro area and has helped moderate the appreciation of its exchange rate vis-à-vis the main third-country currencies. Moreover, the currency union has eliminated much of the pressure on Germany to adjust its burgeoning external surplus, since capital inflows no longer affect its monetary base creation.

The export strength of German manufacturing has been built, on one hand, upon a rate of growth in productivity in manufacturing, which even if declining has been almost constantly higher than that of its European partners; on the other hand, upon a remarkable measure of wage restraint. The analysis of sectoral balances between savings and investment shows that the enormous increase in Germany’s current external surplus in the euro years was determined by rising profits and low investment in the corporate sector, and by the shift of the public sector budget from deficit to surplus. Increased savings by the household sector do not contribute to the explanation of the surplus, contradicting the view whereby the surplus was the result of higher savings by an ageing population.

Finally, the analysis of the capital account of the balance of payments shows that Germany has contributed neither to real investments within the euro nor to sharing the risks implicit in an incomplete monetary union with divergent national fiscal policies.

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