Thursday, November 30, 2023

Europe should pay attention to the debate on Germany’s debt brake

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When Helge braun, close associate of Angela Merkel, proposed to reform the German constitutional public debt limit last week, he stirred a hornet’s nest within his Christian Democratic Union party.

In an article in the Handelsblatt newspaper, Mr Braun proposed amending the constitution to allow the country to take on more debt to support the resumption of the pandemic for years to come. He opened a debate that could decide the economic fortunes of Europe in the post-Merkel era.

The so-called debt brake was introduced in 2009 to fill a gaping hole in Germany’s public finances caused by the global financial crisis. The rule prevents German regions from running budget deficits and limits the federal government’s structural deficit to 0.35% of gross domestic product. Written in the constitution, it forced Germany into budgetary austerity and – politically if not legally – the rest of the euro area with it. Much Europe now sees the austerity of the past decade as an economic and political disaster.

The rule was put on hold when the pandemic struck and Berlin took on huge new debts. The rule is expected to return next year. It could be canceled again if the bounce is short lived. Mr. Braun argued that repeated suspensions undermine the credibility of any fiscal rulebook. Many CDU colleagues would agree. However, his proposal for constitutional amendments to allow for a gradual reduction in new borrowing before reinstating the rule was too onerous for a party steeped in fiscal orthodoxy. His trial balloon was quickly shot down by CDU bigwigs and he was reprimanded by Armin Laschet, the new CDU chief, for not coordinating his intervention.

Many political leaders elsewhere in Europe, however, will be grateful for Mr. Braun’s act of heresy. The IMF and OECD warned that the biggest threat to post-pandemic recovery in advanced economies like the EU is premature fiscal tightening.

“Also timid at the moment, this debate is really necessary,” said Shaheen Vallée, economist at the German Council on Foreign Relations. Mr. Vallée calculates that a return to the debt brake in 2022 would imply a budgetary tightening of nearly 2% of GDP. This would translate into a euro area-wide fiscal tightening of 0.7% of GDP. If restored in 2023, the impact would be less, but southern eurozone economies may still struggle to return to pre-crisis production levels.

Where Germany is going, the euro zone follows. The bloc suspended its debt and deficit limits last year. He will likely give it up again for 2022. But in order to give member states a fiscal path to target, he will soon have to decide whether and how to reform the rules.

France will lead the reform campaign during its EU presidency in the first half of next year, a window between the German parliamentary election in September and the French presidential election the following May. This issue could either reinvigorate relations between Paris and Berlin or seriously damage them. A Germany that sticks to the old rules at home is unlikely to change them in Europe. Mr. Laschet maintains links with President Emmanuel Macron. This will be the real test.

If Mr Laschet is to succeed Merkel as Chancellor, it will most likely be in coalition with the Greens. To reach an agreement with them, the CDU will have to take into account at least some of its major spending plans. In a way, Mr. Braun’s intervention was unfortunately timed. Mr. Laschet, a moderate, tries to strengthen the unity of the party after his election to the leadership by courting his conservative wing. “Whatever he does on the budgetary front, he will have to be very careful,” said Jana Puglierin, head of the European Council on Foreign Relations in Berlin.

But Christian Odendahl, of the Center for European Reform in Berlin, believes that Mr. Braun has done Mr. Laschet and Europe a favor, “to break the taboo, for after the election”. And the Chancellor was probably behind. “It was Merkel holding the pen.”


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