What If Berlin Has to Choose Sides?

ECB strategists in particular and European economic policymakers in general are fixated on the implications for Europe of the Biden Administration's U.S. Inflation Reduction Act of industry subsidies and other taxpayer-funded support. European policymakers see the IRA as welcomed action. They are using it as a means of building political support to expand the European Union's budget through 2027 with spending totaling as much as [euro]2 trillion.

This infatuation with the Biden Administration's IRA has had a particularly strong effect on German policymakers. During the pandemic and with rising energy costs, German households and businesses received significantly more financial support than officially acknowledged. A lot of the energy-related payments to households and firms came from a "shadow budget" that is not discussed in public. ECB policymakers estimate that the shadow budget and official budget together produced about [euro]500 billion in subsidy support during the energy crisis.

That's the upside. The downside is that German policymakers are deeply concerned that in an environment of high interest rates, a lot of business models used by German industry will become unsustainable. "We are going to see a lot more zombie corporations," a German strategist said.

But the biggest fear among...