# Magical square

Magical square of economic policy

The magic square describes an economic system with the following four economic policy goals:

1. Price level stability
2. high level of employment
3. external balance
4. steady and reasonable economic growth

It found its way into the Basic Law for the Federal Republic of Germany as a national goal of overall economic equilibrium .

## Equality of goals

The goals and their equal status are anchored in the German Stability Act of 1967, but do not apply to the monetary policy of the European Central Bank, for example. Price level stability is their primary goal, which is the overriding goal.

Economic policy goals are set for economic and social areas in which unsatisfactory results have already been determined or where undesirable developments are feared. The attention of the state, central bank and social partners should thereby be constantly focused on these points. In this respect, it would have been logical to include the goal of a fair distribution of income in the statutory catalog of goals. However, this target is less clearly definable than the others.

## Problems of goal achievement

Achieving these goals would be in line with macroeconomic equilibrium . The term magical expresses, however, that all goals can hardly be achieved at the same time, since there is incongruity among each other .

In fact, in some situations, goals may be congruent, that is, they may be mutually supportive, e.g. B. Economic growth and high level of employment ( Okunsches law ), but others may behave in competition (value incongruence), e.g. B. short-term price level stability and economic growth or price level stability and a high level of employment ( Phillips curve ). In addition, there is the situation-related target competition, e.g. For example, in a recession, the goals of price level stability and employment do not want to contradict each other; in a boom, competing goals also have a blocking effect, but do not pose any economic threat.

## Measurement of target achievement / indicators

The implementation of the goals formulated in the law in measurable indicators is not easily possible. The following indicators should therefore be understood as examples of practical implementation and not as final definitions of the various objectives.

### Employment level

The level of employment is often measured in terms of the unemployment rate . This practical implementation of the measurement of the "employment level" target is problematic, however, as it can happen that the number of unemployed and those in employment develop in the same direction (e.g. in 2012 and 2013).

${\ displaystyle {\ text {Unemployment rate}} = {\ frac {\ text {Number of registered unemployed}} {{\ text {Number of civilian workers}} + {\ text {Unemployed}}}} \ cdot 100 \, \%}$

If the statistically recorded unemployment rate is less than three percent, it is usually referred to as full employment . The proportion below this is declared as “voluntary”, “frictional” or “seasonal” unemployment .

During the Great Depression in the 1920s, unemployment in Germany was 14 percent. After the two German states were founded in 1949, the Federal Republic of Germany initially had an unemployment rate of over 10%, which then fell steadily. Due to the economic miracle , there was full employment up to and including labor shortages from the mid-1950s to the end of the 1950s. After the end of the post-war boom, the unemployment rate rose to an average of 4% in the 1970s and to around 8% in the 1980s. After reunification , the unemployment rate rose further to up to 13% (2005), since then it has fallen back to below 7%.

### Measurement of economic growth

With a reasonable growth , the general increase in prosperity is referred to a country that has special meaning for less affluent populations. A steady growth is to avoid sharp swings in the development and fluctuations in employment.

Economic growth occurs when real gross national income or real gross domestic product (GDP) increases . In Germany, the amount of goods and services produced per capita in 2000 was twenty-eight times as high as in 1870.

The percentage change in economic growth is recorded retrospectively once per quarter. In Germany, the values ​​for two consecutive quarters serve as a signal generator. In the USA, on the other hand, only a quarterly value is taken and extrapolated for the year.

Phases of particularly strong growth in Germany were the so-called Gründerzeit from approx. 1870–1913 and the period of the economic miracle after the Second World War. The two world wars and the Great Depression in the 1920s and 1930s were phases of particularly strong fluctuations . As a result, growth has not been steady over the past 100 years. Since the founding of the Federal Republic of Germany, growth has shown a course that can be better described with the term "steady". But there were also dents during this period (first weak phase 1966/1967, oil crisis 1973–1975, recessions 1981/1982 and 1993/1994, economic and financial crisis 2008/2009 ).

### Measurement of price level stability

The price level stability is measured with the help of the inflation rate of consumer prices. A shopping cart is put together with the goods usually consumed , the prices of which are collected monthly. If one compares the price level of the shopping basket with that of the previous year, one obtains the change which is called inflation with a positive sign and deflation with a negative sign . The European Central Bank , for example, interprets an inflation rate of close to but below two percent per year as price level stability. However, this information leaves some room for interpretation.

Price level stability means that money in a market economy can perform its functions as a medium of exchange, a store of value and a unit of account.

### Measurement of the external balance

The external trade ratio is sometimes suggested as an indicator for this . It is calculated from the external contribution (= exports minus imports of goods and services) divided by the nominal gross domestic product .

${\ displaystyle {\ text {External contribution quota}} = {\ frac {{\ text {Exports}} - {\ text {Imports}}} {\ text {Nominal gross domestic product}}} \ cdot 100 \, \%}$

During the creation of the Stability Act in the 1960s, Germany was still part of a system of fixed exchange rates ( Bretton Woods system ). From the point of view of the time, the external balance meant a situation that did not endanger participation in this system. However, this was not measured in terms of the external contribution ratio, but rather through the change in the central bank's foreign exchange reserves, which is recorded in the balance of payments. In 1973, when the system of free exchange rates was established, this goal was not redefined. The goal of the external balance is therefore often kept out of the magic square. In fact, however, it can be understood as avoiding a continuous current account deficit or surplus.

## Application in Germany

In 1967 the four goals of the magic square achieved legal status in Germany in the form of the Stability and Growth Act . They are named there in § 1 and together form the state objective of macroeconomic equilibrium ( Art. 109 (2 ) GG ).

The goals were originally considered equal; by European law , however, the price stability (see FIG. was recently granted a prominent position 4 Art. Abs. 2 and Art. 105 TEC , Art. 88 set 2 GG).

In 2013, the Denkwerk Demokratie , a think tank supported by the SPD , the Greens and the trade unions , made the proposal to replace the four previous goals in the magic square with the following four new goals:

• material prosperity and economic sustainability
• Sustainability of government activity and government finances
• social sustainability
• environmental sustainability

This new approach goes back to a study carried out in autumn 2012 by Sebastian Dullien and Till van Treeck for the Denkwerk Demokratie.
In December 2015, the Denkwerk Demokratie published a study entitled The New Magical Square in the Reality Check . The new study defines a slightly modified set of indicators compared to the 2013 study. According to these metrics, social and ecological sustainability deteriorated continuously in Germany from 2009 to 2013. The institute continues to propose using the “new magic square” to depict the development of prosperity and sustainability in Germany.

One speaks of a magic triangle when observing the three goals of price level stability, full employment and external balance. Sometimes there is also talk of the magical pentagon , hexagon , heptagon , octagon or nine- corner , whereby the magic square is then expanded by one or more of the following points:

• balanced public budgets
• fair distribution of income and wealth
• Maintaining a livable environment
• humane working conditions
• Securing resources

## Individual evidence

1. Martin Selmayr : The legal limits of the monetary policy of the European Central Bank - a case study. In: Monetary Policy Without Borders (Ed. Claus Köhler, Armin Rohde), Berlin 2003, p. 181 ( online on Google.Books ).
2. Klaus Bolz: Is a fair distribution of income possible? With a foreword by Heinz-Dietrich Ortlieb . Wilhelm Goldmann Verlag, Munich 1972, 1975. ISBN 3-442-10009-7 . P. 9.
3. See Bofinger (2003) p. 236 f.
4. Unemployment rate since 1950 by area
5. Cf. Bofinger (2003) p. 232 f.
6. See Bofinger (2003) p. 233.
7. Cf. Bofinger (2003) p. 234 f.
8. To calculate the Laspeyres index, cf. CEZANNE (2005) p. 277 f.
9. ^ Krugman, P. and M. Obstfeld: International Economics . 6th edition. Addison-Wesley, Boston 2003, p. 538 .
10. See Bofinger (2003), p. 242 ff.
11. Jürgen Kromphardt : Fundamentals of Macroeconomics . In: WiSo short textbooks: Series Economics . 3. Edition. Verlag Franz Vahlen , Munich 2006, ISBN 3-8006-3309-4 , Part A, p. 4 .
12. ^ The SPD and the Greens are designing fundamentally new economic policies. In: sueddeutsche.de. February 13, 2013, accessed May 11, 2018 .