Doubts grow over Germany’s balanced budget rule

The knives are out for one of the holiest of Germany’s sacred cows.

The debt brake, a 10-year-old fiscal rule that virtually bans Berlin from running budget deficits, has long been a pillar of the country’s political and economic orthodoxy.

Yet just as it celebrates its 10th birthday, an increasing number of economists who previously supported it are questioning whether such a rigid rule is still appropriate.

“In view of the huge investment needs that Germany now has, it has become a hindrance,” said Michael Hüther, head of the German Economic Institute in Cologne.

Once a champion of the debt brake, Mr Hüther is one of a chorus of experts who are demanding a rethink. The complaint is that it is too restrictive, and that more flexibility is needed at a time of zero interest rates and a cooling economy that will curb tax revenues.

Marcel Fratzscher, head of the German Institute for Economic Research (DIW Berlin), said Germany was seeing a “mind shift” away from such diktats.

“There’s this feeling that maybe we overdid it,” he said. “After all, if you take the debt brake seriously, it means that at some point sovereign debt will be abolished entirely.”

The debt brake was introduced in 2009 after the global financial crisis blew a hole in Germany’s public finances. The law, which is enshrined in the German constitution, effectively prohibits its 16 regions from running budget deficits and limits the federal government’s structural deficit to 0.35 per cent of gross domestic product.

Its advent came as Berlin was reeling from two fiscal stimulus packages and a €500bn bank bailout, which left it with an €86bn deficit and a debt-to-GDP ratio of 81 per cent — much higher than the 60 per cent limit set in the Maastricht treaty.

But its genesis lies further in the past, originating at a time in the early 2000s when Germany was the sick man of Europe. The exorbitant cost of reunification had drained state coffers and, with unemployment soaring and debt spiralling, the idea gained ground that strict rules were needed to force spendthrift ministers to behave more responsibly.

The debt brake certainly helped repair Germany’s public finances: every year since 2014 the government has run a balanced budget — known in German as the “schwarze Null”, or black zero. Its debt-to-GDP ratio stands at 60 per cent, and on current projections should drop to 50 per cent by 2022.

Thanks to a booming economy, record employment and bumper tax receipts from business, the Treasury delivered a surplus of €54bn last year.

Meanwhile, no big political party in Germany shows any inclination to deviate from the orthodoxy of the schwarze Null.

Olaf Scholz, the Social Democrat finance minister, who has ambitions to be Germany’s next chancellor, has vowed to cleave to the legacy of his famous predecessor Wolfgang Schäuble: the coalition agreement negotiated last year between his SPD and Angela Merkel’s centre-right Christian Democratic Union insists on balanced budgets, stable finances and “no new debts”.

Yet the economic mood music has changed remarkably since the early days of the debt brake, largely thanks to the European Central Bank’s loose monetary policy; its bond-buying programme and negative interest rates have seen long-term German bond yields trading at close to zero for much of the past couple of years.

“The nominal interest rate is now below the nominal GDP growth rate, so the argument that new borrowing burdens future generations doesn’t hold any more,” said Mr Hüther.

The mind shift is even being felt in that stronghold of fiscal rectitude, the German finance ministry. Observers have linked the change of tone to the arrival of Jakob von Weizsäcker, a former Social Democrat MEP who in January replaced the hawkish Ludger Schuknecht as the ministry’s chief economist.

Mr von Weizsäcker recently invited a group of experts, including Messrs Fratzscher and Hüther, to discuss how Germany could ramp up investment and what that would mean for the debt brake.

“The question is: isn’t there a good deal to be had for investing in our country by borrowing money for free?” said one official with knowledge of the discussions.

The background is growing public concern about under-investment in Germany’s infrastructure — its rundown schools, crumbling bridges, unreliable internet and underfunded army. This has now eclipsed worries about public debt.

Yet some economists reject that as an argument to do away with the debt brake.

“The question is: what are these big investment projects that we need right now?” Lars Feld, professor of economic policy at Freiburg university, told the German press last week. “What is so bad about our infrastructure that we can’t finance it through taxes?”

Mr Feld has argued that investment is low because of Germany’s cumbersome construction permits system, not its commitment to solid public finances. Abandoning the debt brake would leave the country with the “same problems we used to have — more government consumption [of goods and services] and more government transfers. But there won’t be much investment.”

No one is suggesting abolishing the debt brake, a move that would require amending the German constitution. But many economists want to fine-tune it. Mr Hüther has suggested that public investments should be paid for out of a “separate, debt-financed capital budget”.

Mr Fratzscher has called for the debt brake to be superseded by a “nominal spending rule” which ties public expenditure to economic performance, as well as a requirement for governments to pursue positive net investment over the medium term. That would address Germany’s big investment deficit head-on.

“When a government doesn’t invest and just runs down public assets, that’s as unsustainable as if it were to run up a huge fiscal deficit and build up debt,” he said.