At the same time as the Republican party celebrated its US election win on 6 November, Germany’s coalition government fell.
After failing to reach an agreement on providing fiscal stimulus to Germany’s slumping economy, German chancellor Olaf Scholz dismissed finance minister Christian Lindner. This caused the three-party coalition to collapse, as the FDP, led by Lindner, withdrew from government.
With the federal election scheduled for 23 February, reforming the Schuldenbremse, or German debt brake, to allow greater government spending has been widely discussed.
What could a reform look like?
The debt brake, brought into German law in 2009 following the financial crash, limits the federal government’s new debt to around 0.35% of GDP. However, prominent politicians and economists alike have called for a reform of the fiscal rules ahead of the election.
“The issue has been that the German debt brake restricts fiscal policy when it is needed the most, namely during economic downturns,” says Matthias Scheiber, Allspring senior portfolio manager and head of multi-asset solutions.
“Fiscal policy ideally works anti-cyclically to buffet any economic slowdown with higher spending to support demand. It naturally puts more pressure on the central bank to support growth with lower interest rates, though inflation has been sticky, making the job of the ECB [European Central Bank] more difficult.”
There are few alternatives to modifying the debt brake against the background of the current challenges facing the German economy, according to Carsten Roemheld, capital market strategist at Fidelity International.
“The investment needs in a wide variety of areas have become too great, and they are an essential prerequisite for growth in the future. This growth is necessary, also in order to be able to meet the increasing demands on the part of the state. However, the funds must be used exclusively for investments and not for consumer spending or redistribution.
“This is the only way to ensure the capital works profitably and generates corresponding growth. Under these conditions, the effects on competitiveness in the economy and on the capital markets should be very positive. I strongly suspect there will be a modification of the debt brake after the federal elections, but I still consider a sound fiscal policy to be essential.”
Stefan Hofrichter, global economist and head of macro at Allianz Global Investors, agrees that a reform of the debt brake in its current form seems reasonable, though any changes would have to adhere to the European fiscal and stability pact.
“On the one hand, Germany’s investment backlog in the areas of education, digitalisation, energy, infrastructure and defence can also be explained by the relatively low public investment volume over the past decades compared with other EU countries. In the long term, higher investments should be reflected in stronger trend growth.
“On the other hand, Germany, with a relatively low debt ratio of approximately 63% of GDP compared to international standards, already has fiscal room for manoeuvre.”
A potential template for reform has been floated by the German Council of Economic Experts (GCEE) – a body of economists set up to evaluate the federal government’s economic policies. The council has suggested a slightly higher structural deficit than before for debt ratios below 90%, plus longer adjustment periods following an overshoot in spending.
“In my view, a stronger prioritisation of public spending should take place,” Allianz GI’s Hofrichter adds. “For example, public consumption accounted for an average of approximately 19% of GDP in the two decades before the euro debt crisis but has been around 22% since 2020.
“More government investment and less government consumption, along with a reduction in bureaucracy, would be desirable to improve Germany’s competitiveness in terms of trend growth.
“Beyond the GCEE, the Deutsche Bundesbank has also argued in favour of some modification of the current debt break.”
Read the rest of this article in the February edition of Portfolio Adviser Magazine