Germany's debt brake won't survive this war
Commitment to debt brake and multiplication of special funds obscures fiscal policy and undermines its stabilization properties
There is a growing discussion about the macroeconomic policy response to the current war in Ukraine especially as sanctions are escalating and embargo on oil and possibly gas in the future will take a higher toll on the economy than initially planned.
Blanchard and Pisani-Ferry gave a good overview of the combination of fiscal measures that would be required and their potential size, 1.5-2.0% of GDP to cushion the shock. This is however based on macro-economic estimates of the expected economic shock that are very debatable (more on this in a separate note).
It’s therefore useful to look at what the current fiscal plans announced by EU Member States look like. All of them have just released their Stability Programmes, which gives some clue about the course of fiscal policy in Europe as it stands. It is damning for the European Commission nonetheless that these fiscal plans for 2023 are being made with the guidance that European fiscal rules should be reinstated in 2023.
The European Commission is likely to issue a new Communication calling for an extension of the general exemption clause to 2023 but, it should have done so long ago. This could have prompted a more serious conversation about fiscal policy in Germany.
As it stands, the German government continues to pretend that it will abide by its Constitutional debt break in 2023 and achieve a structural deficit of no more than 0.35% of GDP then. The danger of maintaining this fiction is to dangerously tighten policy in the face of an external macroeconomic shock but also to dangerously obscure its true fiscal policy by a growing number of artefacts and accounting voodoo.
Here is therefore some deciphering of the fiscal policy of the new German Government.
· The action started in December 2021 with the first piece of legislation that was translating the Coalition Agreement into fiscal action. The December 13th supplementary budget passed by the Bundestag allowed to transfer into 2022 the unused borrowing in excess of the debt break in 2021. This was a critically important step because the Fund for Climate and Transformation of some EUR 60bn agreed in the coalition agreement was not new spending but actually financed by unused funds voted to overcome the impact of the pandemic in 2021. This second supplementary budget for 2021 was passed by the Bundestag on January 27.
· The previous government had authorized 240 bn new debt in 2021 (41 allowed under the debt break and 198.77 in excess), of which only EUR 16.4bn were NOT used and could be carried over. The previous government had also tabled some 99.7bn in debt in excess of the debt ceiling in its draft budget of 2022. But prior to the war in Ukraine, the new government had chosen not to augment this amount.
· The second budget proposal for 2022 and a benchmark resolution on the budget plans until 2026 was agreed upon by the government on March 16, 2022. Here, the 99.7bn in debt for 2022 were adopted from the plans of the previous government. On April 27, however, the government agreed to amend this proposal by including a supplementary budget increasing debt by another EUR 39.2bn.
· This was done to account for the growing demands on fiscal policy, in particular the two successive plans announced in March 2022 in response to the Ukraine war for some16bn each. But this new additional borrowing can only be adopted with a redemption plan. This could also be the opportunity to revisit the redemption plans for 2020 and 2021 that will weigh considerably on fiscal policy going forward.
· In addition, on 16 March 2022, the federal cabinet adopted the Act Establishing a Special Fund for the Bundeswehr (Gesetz zur Errichtung eines Sondervermögens Bundeswehr) and on April 17th, the Act Amending the Basic Law (Article 87a) (Gesetz zur Änderung des Grundgesetzes (Artikel 87a)).
· This constitutional amendment was important because the German Basic Law stipulates that the Army, its forces, and its budget must appear in the Federal Budget. So an amendment was introduced to allow for the creation of a one-off special fund with credit authorization worth €100bn not constrained by the debt brake. Essentially, the German Bundestag changed the Constitution to bypass another Constitutional provision rather than open an amendment of the debt break rules.
· All in all, the fiscal plans announced and voted are supposed to have a meaningful fiscal impact in 2022 but also going forward, the Annexes of Germany’s Stability Programme forecast that the discretionary fiscal measures announced to respond to the effects of the war in Ukraine should weigh nearly 0.5% of GDP, the climate fund some 0.4%, the Bundeswehr fund some 0.5%. These measures will also have substantial effect in the coming years in ESA accounting terms.
· But the beauty of these off balance sheet driven expenditures is that while they do not change the fiscal picture in ESA accounting terms, they are not treated as deficit spending in German National Accounting (financial transactions do not count in the deficit), as such the Government claims that it will be possible to display a structural deficit of some 2.25% in 2023 in ESA terms and yet comply with a the debt Brake that sets a maximum structural deficit of 0.35% of GDP in national accounting.
· However, even in national accounting, the promise to meet the debt break in 2023 seems however wholly unlikely because on top of the contributions to these funds (accounting for nearly 1% of GDP in 2023), the structural deficit would need to shrink by more than 1% of GDP for the structural deficit to be below 0.35% of GDP.
The German government doesn’t have a lot of options and could be seriously constrained if it sticks to the current plan. It has only a few options available:
1) If nothing happens, the German government will have to undertake a serious fiscal consolidation effort in 2023 precisely when recession risks are at their peak. This is currently what Finance Minister Lindner claims to be his plan and against which here is little push back in the coalition.
2) The forthcoming decision by the European Commission to extend the general exemption clause of the SGP for another year could provide the perfect cover for the German government to kick the can down the road. This would allow keeping the illusion and the FDP’s promise intact for the moment.
3) The path of least resistance is probably to keep digging trenches in the schuldenbremse by using and abusing the flexibility offered by the calculation of the cyclical components and the output gap. A thorough revision of the calculation methods such as that proposed by Dezernat Zukunft would create short term fiscal space and allow to delay the debate on a more thorough reform of the rules further down the road.
4) But a decision by the German Constitution Court on the new funds/SPV could also be coming in the coming months and somewhat challenge this practice of voodoo accounting and obfuscation. After throwing this conversation away for a long time, it might then come back like a boomerang and impose a reckoning.