What Germany’s elections mean for the country’s debt debate


Newsletter: Europe Express

Since the pandemic hit Europe last year, Germany has experienced a spending spree, ending six consecutive annual budget surpluses with the biggest borrowing spree since the country’s reunification in 1990.

As Germans prepare to vote in Sunday’s parliamentary elections, economists are trying to determine whether to expect a return to strict fiscal discipline under the next government, as well as what the consequences will be for a debate in Brussels on resetting the EU’s own fiscal rules. .

“Fiscal policy is the real problem not only for the next German government, but also for the EU, as Germany sets the tone for the rest of Europe,” said Katharina Utermöhl, senior economist at Allianz.

Germany’s Social Democrats have taken the lead in opinion polls, making their leader Olaf Scholz the frontrunner to replace Angela Merkel as chancellor by forming a left-wing coalition that should prioritize higher spending over rapid debt reduction .

But the competition remains wide open. Neither Scholz nor CDU center-right candidate Armin Laschet are expected to win a majority and months of post-election haggling are expected before a ruling coalition can be agreed.

Here are three big questions economists are asking as they examine how the German election is likely to change national and EU fiscal policy.

What to do about the debt brake?

The first big problem is how the next German government will handle the country’s constitutional “debt brake”, which was introduced in 2009 to prevent public debt from skyrocketing after the global financial crisis.

The rule has been suspended since the start of the pandemic, allowing the federal government to raise 370 billion euros in additional debt in 2020 and 2021. But it is expected to resume its effects in 2023, limiting new federal government borrowing to just 0 , 35 per cent of gross domestic product, adjusted for the business cycle – currently just over 10 billion euros per year.

© Jacobia Dahm / Bloomberg

The Greens are the only party to demand that the debt brake be reformed so that 500 billion euros can be spent over 10 years for the country’s transition to carbon neutrality.

Most economists believe the rule is here to stay, as any constitutional change requires a two-thirds majority in both houses of parliament. Scholz seems to agree, telling Handelsblatt last week that this is why the Greens’ climate investment plan “will collapse like a house of cards”.

So, is Germany doomed to return to a strict fiscal straitjacket? Not quite, according to Guntram Wolff, director of the Bruegel think tank. He said all major parties pledge to invest more to tackle issues like climate change and digital politics after German public investment, net of depreciation, has been negative for much of the past. decade.

“It doesn’t matter what government we have, they’ll have to invest more, so the question is what’s going to pay out and I think that’s going to be the debt brake,” Wolff said. “It will be a bitter political struggle. “

Line graph of general government budget balance (% of GDP) showing Germany's plans to return to fiscal discipline

One way to get around the constraints of the debt brake is to build up an off-balance sheet fund that is excluded from the deficit. One of these funds finances the German railways. Hamburg has another for building schools.

But Marcel Fratzscher, director of the German Institute for Economic Research, drew up proposals for such a government fund in 2016 and warned that these vehicles were difficult to set up because they had to be independent of state control. “It makes less of a difference than you might think because you can only use this workaround to a specific and limited extent,” he said.

Has Germany’s fear of indebtedness faded?

Growing public concern about global warming – especially after the devastating floods that killed 181 people in the west of the country earlier this year – has made climate change a priority for many voters and has led some economists to conclude that attitudes towards public investment and debt are no longer so rigid.

Flood damage to the Rhine town of Insul during summer flooding in Germany
Flood damage to the Rhine town of Insul during the summer floods that hit Germany © Michael Probst / AP

“The perception that public debt is a problem has changed a lot over the past five years,” said Christian Odendahl, chief economist at the Center for European Reform in Berlin. “The orthodox view of the eurozone debt crisis is changing and there is now a more gradual approach to climate change. ”

Germany’s ability to borrow at negative interest rates, which earns it interest from investors who buy its bonds, strengthens the case for increased government spending, he added.

But two likely election results imply that one of the two main parties forms a coalition with the Greens and the Free Liberal Democrats – parties with radically opposed tax views. The first favors higher taxes and more spending; the latter tax cuts and debt reduction.

Goldman Sachs thinks they will cancel each other out. The US investment bank predicted that if the SPD formed a coalition with the Greens and the FDP, it would increase Germany’s debt by € 75 billion over four years. As part of a CDU / CSU-led coalition, Goldman is forecasting a slightly lower debt increase of € 50 billion.

Where does that leave the EU?

The European Commission this month promised a public consultation on a possible overhaul of its fiscal rules, which many economists deem inapplicable after the debt of several EU countries soared to over 100% of GDP during the pandemic.

Like Germany, the EU suspended its fiscal rules last year and these are also expected to come into force in 2023. “said Erik Nielsen, chief economist at UniCredit.

While most economists believe the next German government will find ways to get around its own debt brake, they are less sure that Europe can count on Berlin’s support to ease EU rules, which force countries to reduce their debt to 60% of GDP.

In an interview with the FT in June, Scholz seemed hawkish on the issue, saying that a “common currency needs common rules and that our rules have proven to offer the necessary flexibility”.

Others advocate an even harder line. “Liberals are likely to be in government and they are among the most Eurosceptic parties in Germany,” said Fratzscher, stressing that the FDP would demand from the finance ministry its price for agreeing to join a government.

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