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Since the pandemic hit Europe last year, Germany has been on a spending spree, ending six consecutive annual budget surpluses with the biggest borrowing binge since the country’s reunification in 1990.
As Germans prepare to vote in Sunday’s general election, economists are trying to figure out 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 issue for not just 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 favourite to replace Angela Merkel as chancellor by forming a left-leaning coalition that is expected to prioritise higher spending over rapid debt-reduction.
But the contest remains wide open. Neither Scholz nor the centre-right CDU candidate Armin Laschet is likely to win a majority and months of post-election horse-trading are expected before a ruling coalition can be agreed.
Here are three big questions that economists are weighing as they consider how the German election is likely to alter national and European fiscal policy.
What to do about the debt brake?
The first big issue is how Germany’s next government will handle the country’s constitutional “debt brake”, which was introduced in 2009 to prevent public debt from soaring after the global financial crisis.
The rule has been suspended since the pandemic struck, allowing the federal government to raise an extra €370bn of debt in 2020 and 2021. But it is due to snap back into effect in 2023, restricting new borrowing by the federal government to only 0.35 per cent of gross domestic product, adjusted for the economic cycle — currently just over €10bn a year.
The Greens are the only party calling for the debt brake to be reformed so €500bn can be spent over 10 years on the country’s transition to carbon neutrality.
Most economists think 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 destined to return to a strict fiscal straitjacket? Not quite, according to Guntram Wolff, director of the Bruegel think-tank. He said all the main parties are promising to invest more to tackle issues like climate change and digital policy after German public investment, net of depreciation, was negative for much of the past decade.
“No matter which government we get, they will need to invest more, so the question is what will give and I think it will be the debt brake,” said Wolff. “It is going to be a bitter political struggle.”
One way to circumvent the constraints of the debt brake is to set up an off-balance sheet fund that is excluded from the deficit. One such fund finances German railways. Hamburg has another for building schools.
But Marcel Fratzscher, head 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 as they had to be independent of state control. “It makes less difference than you think as you can only use this workaround to a specific and limited extent,” he said.
Has Germany’s fear of debt faded?
Mounting 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 led some economists to conclude that attitudes to public investment and debt are no longer so rigid.
“The perception that public debt is an issue has changed quite a bit in the past five years,” said Christian Odendahl, chief economist at the Centre for European Reform in Berlin. “The orthodox view of the eurozone debt crisis is shifting and now there is a more progressive approach to climate change.”
Germany’s ability to borrow at negative interest rates, earning it interest from investors who buy its bonds, strengthens the case for higher public spending, he added.
But two likely outcomes for the election involve one of the two main parties forming a coalition with both the Greens and the liberal Free Democrats — parties with starkly opposing fiscal views. The former favours 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 FDP, it would increase Germany’s debt by €75bn over four years. Under a coalition led by the CDU/CSU, Goldman forecasts an only slightly smaller debt increase of €50bn.
Where does this leave the EU?
The European Commission this month promised a public consultation on a potential overhaul of its fiscal rules, which many economists say are unworkable after the debt of several EU countries soared during the pandemic to more than 100 per cent of GDP.
Like Germany, the EU suspended its fiscal rules last year and they, too, are due to come back into force in 2023. “At the end of the day you can’t be too innovative at the European level without knowing what the Germans do,” said Erik Nielsen, chief economist at UniCredit.
While most economists think the next German government will find ways to circumvent its own debt brake, they are less sure that Europe can count on Berlin’s support to relax EU rules, which require countries to bring their debts back to 60 per cent of GDP.
In an interview with the FT in June, Scholz sounded hawkish on the issue, saying a “common currency needs common rules and our rules have been shown to provide the necessary flexibility”.
Others advocate an even tougher line. “The liberals are likely to be in government and they are among the most Eurosceptic parties in Germany,” said Fratzscher, pointing to expectations that the FDP will demand the finance ministry as its price for agreeing to join a government.