Germany’s new budget and medium-term spending plan, announced last Wednesday, come at a doubly delicate moment. Both within Germany and at EU level, what post-pandemic fiscal policy should look like is becoming an increasingly pressing question.
Berlin’s budget plans send a signal of how Europe’s biggest economy will deal with that question, even though they are unlikely to survive this autumn’s elections in their current form.
“This is for sure not the final word . . . a new government will want to leave their own mark on the budget for 2022,” says Katharina Utermöhl, senior economist for Europe at Allianz. But the budget “highlights the difficulty of switching from a fiscal version of ‘whatever it takes’ to fiscal business as usual”, she adds.
Under the plans, which include a 2022 budget and tax and spending outlines for 2023-2025, the emergency suspension of Germany’s debt brake — the strict limit on new borrowing inscribed in the German constitution — continues into next year. “We have to do this to have a sensible fiscal policy”, says Philippa Sigl-Glöckner, director of the think-tank Dezernat Zukunft and a former finance ministry official.
The suspension allows the government to borrow around €100bn next year. But in 2023 the deficit is projected to fall to under €10bn to respect the debt brake. This will happen just when “growth projections tail off and unemployment remains higher than before the pandemic”, warns Sigl-Glöckner.
The planned tightening may not be quite as drastic as the headline numbers suggest. The debt brake rule does not count borrowing that is classified as drawing down a notional “reserve” of previously budgeted but unspent money. Berlin’s plans to spread such reserve drawdowns over the next few years means the real macroeconomic consolidation is correspondingly softer.
Notwithstanding these sleights-of-hand, the rule’s central place in policy planning and rhetoric means that with concern over debt overshadowing how to invest in the carbon transition, “you don’t focus on what’s important”, says Sigl-Glöckner.
And things will be “painful” from 2023 on, warns Utermöhl. The government’s repayment schedule for Covid-related debt kicks in then, and gets much more demanding from 2026. It will be “difficult to find enough room to invest” despite the looming challenges of the green and digital transitions, she says.
What does this mean for the eurozone? According to Utermöhl, the country’s delay to budget consolidation “helps in the short term by keeping a lid on fiscal divergence” between states such as Italy, which may go on a “fiscal splurge”, and Germany, which could “set the tone for eurozone fiscal policy” if it started to normalise.
She also points out implications for monetary policy. Apart from emergency pandemic debt purchases, the ECB has bound itself to hold only a limited share of each country’s total debt. A sharp reduction in German debt issuance “could see the European Central Bank run into debt limits” in its regular asset purchase programme.
Sigl-Glöckner is also concerned about the signal Germany’s direction sends about the looming debate over the EU’s fiscal rules that limit deficit spending by member states — which are also suspended through next year. “If Germany is telling you that by 2023 it’s ‘back to the rules’ you’d better start consolidating,” she says.
The finance ministry emphasises that federal investment spending is set to settle at above €50bn a year — over a quarter more than before the pandemic. And with luck, growth may be strong enough to bring down the deficit without much fiscal effort.
The risk, however, is for a “hard landing” in 2023, says Utermöhl, both “for fiscal policy . . . and for the [tax and spending] promises that will have been made” in the election campaign.
Despite all these warnings, Germany’s policymakers have boxed themselves in by the politics of rules. “Most political actors still think you don’t win an election when you openly criticise the debt brake”, Sigl-Glöckner says.
The exception is the Greens, who want to reform it — so “it will be interesting to see how the Greens do”, she adds.
But whether the election defies Germany’s conventional wisdom or solidifies it, the consequences will matter well beyond its borders.