German debt brake ‘too rigid’, say government advisers

The German government’s economic advisers have proposed a wide-ranging reform of the country’s so-called debt brake, in a move that could put pressure on politicians across the party spectrum to ease the constitutional curb on new borrowing.

“In its current form, the debt brake is more rigid than necessary,” the German Council of Economic Experts said in a policy brief published on Tuesday. “It restricts the fiscal space for future-oriented expenditure.”

The recommendations will be music to the ears of leftwing and centrist politicians in Germany who have long argued that the debt brake is an unnecessarily restrictive “straitjacket” on fiscal policy.

In force since 2016, the rule, which is enshrined in the German constitution, limits the country’s structural deficit to 0.35 per cent of gross domestic product, adjusted for the economic cycle. It was suspended during the Covid-19 pandemic, and again after Russia’s full-scale invasion of Ukraine, but reinstated this year.

However, it remains a major bone of contention between the left and the right in German politics, and has caused a huge rift in Chancellor Olaf Scholz’s fragile coalition government.

Scholz’s Social Democrats and their partners the Greens want to reform the borrowing cap, saying it hinders the massive investments in infrastructure and green technology that the German economy so desperately needs.

Robert Habeck, the Green economy minister, recently compared Germany to a “boxer who’s entered the ring with both hands tied behind his back”.

But the third party in Scholz’s coalition, the liberal Free Democrats (FDP), are wedded to the rule, saying it protects future generations from having to shoulder an ever-expanding pile of public debt. The opposition Christian Democrats (CDU) also oppose any loosening of the brake.

The debate about the rule intensified after a bombshell ruling by Germany’s constitutional court in November striking down the government’s use of off-budget funds to circumvent the debt brake, throwing Berlin’s spending plans into disarray.

In their policy brief the five economic advisers argue that there should be a softer transition between periods when the debt brake is suspended and when it comes back into force. They said this transitional phase would allow for structural deficits “above the normal limit”, though they “must be reduced year by year”.

The economists also proposed that deficit limits should depend on Germany’s overall debt-to-GDP ratio. If this falls below 60 per cent, the upper ceiling of the structural deficit should be 1 per cent of GDP. If it is between 60 and 90 per cent, a deficit of 0.5 per cent of GDP should be allowed, adding that the existing ceiling of 0.35 per cent of GDP should only apply if the debt-to-GDP ratio hits or exceeds 90 per cent.

“Deficit limits that allow higher borrowing than before at low debt ratios moderately expand the fiscal space without jeopardising sustainability,” said council member Veronika Grimm, a professor of economics at the University of Erlangen-Nuremberg.

The idea of reform arose after the council ran simulations of how Germany’s debt ratio would develop in the future under the existing rules. These showed that the debt-to-GDP ratio would steadily fall, even if the government maxed out on its net borrowing limits and even if there were regular crises when the debt brake was suspended.

The simulations show that even if the debt brake was reformed as the economists proposed, Germany’s debt-to-GDP ratio would drop to 59 per cent by 2070 — below the EU limit. Current government projections show the debt-to-GDP level dropping to 64 per cent this year, which is lower than other major EU economies.

However, it is unclear how the experts’ proposals can be implemented. Any change to the debt brake would require a two-thirds majority in parliament to amend the constitution — yet the FDP and CDU have so far opposed any reform.