The Economist explains
Why German politicians are fighting over the debt brake

The rule to limit government borrowing may have created more problems than it solved

IN MOST COUNTRIES politicians woo voters by promising to lavish them with cash. In Germany they curry favour by pledging fiscal rectitude. Armin Laschet, leader of the Christian Democratic Union (CDU) and the favourite to succeed Angela Merkel as chancellor, is standing behind the “debt brake” enshrined in the constitution, which limits annual federal government borrowing (adjusted for the economic cycle) to no more than 0.35% of GDP. Olaf Scholz, the finance minister in Germany’s coalition government and the Social Democratic Party’s candidate, is keen to leave it be too. The Green Party, however, is less supportive, arguing that the rule should be tweaked to allow for greater investment. For now the debate is academic; the rule is suspended until 2023 because of the economic damage caused by the covid-19 pandemic. But soon it will have very real consequences, both for Germany and Europe.

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The debt brake was written into the German constitution in 2009, and included an even harsher limit on the federal states, which were supposed to run balanced budgets adjusted for the economic cycle from 2020 (the pandemic forced them to invoke the escape clause too). In 2011 the euro area adopted a version in its fiscal rules. The constraint on profligate politicians was supposed to avoid frivolous spending that saddled future generations with debt repayments. It was also supposed to bolster confidence in the government’s ability to repay its debts, lowering borrowing costs. When the pandemic hit and the emergency clause invoked—enabling one of the largest fiscal responses in the world, worth over 6% of GDP in 2020—the debt brake was heralded as a success. Earlier frugality had enabled the crisis-fighting largesse, the logic went.

In truth, the debt brake probably created more problems than it solved. Sustainable public finances are a worthy goal, to be sure. But for Germany, the debt brake imposed a limit that was tighter than necessary. What matters is the relationship between growth of public debt, which depends on new borrowing and interest rates, and of the economic growth supporting it. Interest rates that sank below zero even before the pandemic meant Germany had room to borrow more than 0.35% of GDP, even in good times, and invest to benefit future generations. Instead, the rule meant that investment was squeezed, and between 2012 and 2017 was not high enough to stop the public capital stock from shrinking. Meanwhile, the flexibility that was baked in, to exclude transactions that don’t affect the federal government’s net assets, encouraged spending through non-transparent and inefficient financial arrangements.

Some people hope that the pandemic could herald a new era of fiscal rules, including reform of the debt brake. An influential younger generation of German economists feels more relaxed about borrowing, though Messrs Laschet and Scholz are clearly calculating that public opinion has moved rather less. Now the debate is over how quickly the debt brake should be reinstated, and whether there should be provisions allowing for investments to help Germany transform into a greener and more digitised economy. Too tentative a return would lead to howls from inflation hawks. But a screeching halt in spending could crash the economic recovery, with worrying implications for Germany’s neighbours. The European Union is due to review its fiscal rules soon. A German government rigidly applying fiscal restraint at home is unlikely to take a relaxed approach elsewhere.

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