Election throws Germany’s legendary ‘debt brake’ into question

Germany’s impending election is raising big questions about the future of the country’s most talismanic symbol of its tight public finances: the infamous “debt brake.”

Politicians in the world’s No. 3 economy are querying whether this legendary halter on government borrowing still makes sense in a world of uncertainty characterized by the re-election of Donald Trump, the war in Ukraine and Europe’s economic decline.

Written into the constitution by then Chancellor Angela Merkel in 2009, the Schuldenbremse amendment — which limits the structural budget deficit to 0.35 percent of gross domestic product in normal times — is beginning to look unsustainable in a world of mushrooming demands on the public purse.

The fiscal straitjacket has already helped to bring down Chancellor Olaf Scholz’s ruling coalition, making an election likely on Feb. 23.

The coalition collapsed earlier this month largely because Finance Minister Christian Lindner’s proposals to keep the deficit within limits all proved unacceptable to his coalition partners, the Social Democratic Party (SPD) and the Greens. After Scholz fired Lindner, his fiscally conservative Free Democratic Party (FDP)  left the government, paving the way for an election in February, seven months earlier than scheduled.

Recognition of the need for a major overhaul is growing. This month, the government’s Council of Economic Advisers floated a proposal to adopt rules allowing for more investment in a bid to ease tensions. Meanwhile, the Deutsche Bundesbank — usually a bastion of fiscal conservatism — has been arguing for months that a reform allowing “moderately higher borrowing headroom” would be justifiable, as long as the overall public debt ratio remains low.

But getting rid of the Schuldenbremse before the elections is not so easy: any change would require a two-thirds majority in both the upper and lower houses of parliament. The far-right Alternative für Deutschland (AfD) opposes any reform, as does Lindner’s FDP.

Tactical reasons, meanwhile, suggest the center-right Christian Democrats are unlikely to support anything that would only prolong their time in opposition, and would in any case want to draft any new version from a position of power.

But there is one argument in moving quickly: opinion polls suggest that in the new Bundestag, the AfD and hard-left Sahra Wagenknecht Alliance could win enough seats to block any proposal, giving them an unacceptable degree of leverage over the country’s political mainstream. That creates an incentive to do a deal now, rather than leave it a hostage to fortune.

The new Green Party leader Felix Banaszak said at the weekend he hoped CDU leaders at the state level would pressure their Berlin colleagues for an immediate change to the amendment “because they see that this reform is necessary.”

“I would love to do it, but whether there’s enough time — I don’t know,” SPD Chair Saskia Esken told POLITICO last week.

Friedrich Merz, the man tipped to head Germany’s next government, appears to have grasped the logic and drawn the consequences already. Kicking off his campaign last week, the CDU leader — previously an outspoken advocate of the debt brake — surprised voters by indicating he’s now open to relaxing it. 

“Of course, it can be reformed,” said Merz. “The question is, why? For what purpose? What is the result of such a reform?”

While Merz said he wouldn’t back a reform to allow higher spending on consumption or welfare, if extra borrowing were to boost investment “then the answer may be different.”

State of exception

The existing amendment does have some flexibility: it can be suspended “for natural disasters or unusual emergencies beyond governmental control and substantially harmful to the state’s financial capacity. ”

Germany made full use of that option in 2020-2022 in response to the pandemic and the war in Ukraine. But as ‘normality’ returned, the rule came back into effect, immediately forcing Berlin into budgetary acrobatics to keep the headline borrowing number legal.

An accounting trick under which ever-larger blocks of spending were hived off into special purpose vehicles (Sondervermögen) to dodge the official budget net was struck down by Germany’s highest court last December, after drawing criticism not just from Germany’s neighbors, but also the Bundesbank.

Both Scholz’s SPD and the Greens were ready to suspend the rules again this year due to the financial consequences of the war in Ukraine and the ensuing energy crisis. But Lindner refused to play ball.

Softening the debt brake would allow for more public investment at a time when Europe’s largest economy is in dire need of support. German industry is facing multiple crises as long-standing challenges from demographics and digitization collide with the dual threat of a U.S. trade war and the alarming loss of global competitiveness by the country’s automotive sector.

“Any serious efforts to fundamentally reform and improve the German economy will have to come with fiscal stimulus,” said ING Global Head of Macro Carsten Brzeski.

Time to say goodbye

For many observers outside Germany, the amendment has become obsolete, overtaken by a new set of realities — among them, a new set of European fiscal rules. In that vein, Greek central bank chief Yannis Stournaras, who led his country through the sovereign debt crisis as finance minister, told POLITICO last week Germany should drop it altogether.

“With all due respect, I think it’s superfluous now,” Stournaras said.  “Since we have new fiscal rules [in Europe], which are much more realistic than the previous ones, nobody needs a second brake.”

But Germany — and specifically the Bundesbank — does not appear ready to entrust fiscal responsibility to Brussels just yet. On Tuesday, the Bank criticized new European fiscal adjustment procedures describing country-specific budget limits as “highly complicated”. It added that the way limits had been set up was “quite non-transparent”. In Frankfurt, as in Berlin, doubts persist about the credibility of any promises to cut deficits over seven years, particularly since European governments rarely last that long.

Even the Green Party has chosen not to call for a full repeal, wary of being branded fiscally irresponsible. Over the weekend, its new leaders squashed a proposal to that end by the party’s youth organization. The Schuldenbremse may be on the way out, but killing it off will still require a degree of unity that has been beyond German politicians in recent years.

Nette Nöstlinger contributed reporting from Berlin.