The New Constitutional Deficit Rule for Germany: a New Model Governing Deficit and Debt

Posted by Guilhem Blondy

Dr. Christian Kastrop, from the German Federal Finance Ministry, was invited to present the new constitutional German fiscal rule and its implications for Public Financial Management at an informal meeting organized by the Fiscal Affairs Department of the IMF September 3, 2009.

The new constitutional fiscal rule limits the structural deficit of the Federation at 0.35 percent of GDP and requires structurally balanced budgets for the regions (Lander). The annual maximum permissible net borrowing is calculated every year by adding this structural component the expected balance of financial transactions and a cyclical component based on the output gap used as hypothesis for the preparation of the budget. Structural deviations from the allowed limit at the execution stage will be recorded in a control account and will have to be compensated by reductions of the net borrowing in the following years. Exceptions are only allowed in two cases (natural catastrophes and extraordinary emergencies necessitating special financing needs) and debt accumulated under these exceptions will have to be redeemed through a binding amortization plan. The rule will be fully applicable after a transition period until 2015 for the federation and 2019 for the Lander.

Dr. Kastrop presented the models, which influenced the design of the new rule (European Stability and Growth Pact, Swiss Debt Brake). He explained the advantages expected from this system, in comparison with the previous “golden rule”:

·         the choice of a Deficit Rule is consistent with the Stability and Growth Pact of the EU,

·         the cyclical component should avoid a procyclical bias,

·         the control account, inspired from the Swiss model, is designed to ensure compliance of the execution with the budget and time consistency of the fiscal policy. It acts as a “memory and buffer” if non-compliance with the rule is established ex post,

·         the target does not depend on the definition of the concept of investment and avoid discussions about “human capital” or debates on the depreciation rates of assets,

·         the coverage of the rule has been extended to special accounts of the Federation, which were outside the scope of the previous rule.

He underlined that the rule is a binding national stability pact which should be an anchor for sustainability and make more credible the German consolidation strategy after the crisis. The structural component of 0.35 percent of GDP would correspond to an average annual net borrowing of 8.5 bn euros against 25 in recent years under the previous “golden rule”.

The implementation of the rule is still a work in progress and further steps include the definition of a rigorous process to calculate the annual net borrowing limit (including the calculation of the output gap) and modifications in budget preparation (strengthening of the role of the finance ministry in the definition of sectoral expenditure ceilings consistent with the aggregate limit). The tight control on the level of expenditure should shift the focus of the fiscal policy on the quality of public spending, which will necessitate to move the German budget structure from an input to an output-oriented classification.

Other features of the Public Financial Management system should be less affected, like the  medium-term financial planning or accounting.

In conclusion, the vote of the new German constitutional rule can be seen as a remarkable political achievement, as the focus of the political opinion is still in most countries on crisis recovery and not on fiscal consolidation. This constitutes the framework for the German exit strategy and contributes to a restoration of confidence in sound public finances. Nevertheless, some uncertainties about the implementation of the rule and the related public financial management reforms will now need to be addressed.

Comments

[Christian Schiller]

There was indeed a large majority among the political leaders of the country to push the debt brake through. The policy advisors however were less convinced about such a strict rule. Many academics see the debt brake imposing an excessive and counterproductive fiscal discipline that future governments will not be able to respect, given the spending pressures of an aging society. I would like to refer the reader to my blog posting of February 23, which discusses these issues.

[Mark Montgomery]

Unfortunately I agree with Christian that history has shown that the buying of votes in the present with borrowed money from the future has sufficiently strong incentives to focus much creativity on work arounds. I am assuming that the German measure is similar to the U.S. in requiring a much larger number of votes to over-rule, in which case the required discipline will likely be more successful. Anything that requires fiscal discipline in the U.S. would be welcomed by this citizen.