Debt Brake for Germany--Could it be too Strict?

Posted by Christian Schiller


When the Federalism Reform Commission II presented its report to the general public on June 23, 2008, it was clear that a debt brake for the federal government and the governments of the Länder (the federal states) would come, but how tight remained open (see my posting Germany: Fiscal Reform Commission II presents report of June 30, 2008). Now, on February 12, 2009, the federal government and the governments of the Länder have agreed on the specifics. It is expected that the new debt brake will be incorporated into Germany’s basic law in June 2009 and become effective on January 2011.

Agreement has been reached on a zero limit on net borrowing for the Länder and a limit of 0,35 percent of GDP for the federal government budget deficit. These are the general rules. But there will a transition period and there will be exceptions.

The Bund and the Länder have a number of years to adjust their fiscal position. In addition, in the coming years, the rich Länder and the Bund will assist the poor Länder to cut back their stock of debt by providing an annual amount of € 800 million to them. The zero net borrowing limit for the Länder will then become effective in 2020.

The federal government is expected to respect the new debt brake for the first time in 2016. Deep recessions and natural disasters would, however, permit higher borrowing, provided there is a 2/3 majority in the parliament; also, conjunctural fiscal balances will be tolerated under the condition that they are “symmetric”. Although all technical details are not yet clear, a special account will be established to monitor conjunctural borrowing and repayments.

Chancellor Merkel and Finance Minister Steinbrück very much welcomed that result. Others, however, have expressed doubts and concerns.

One of them is Prof. Berthold Wigger, University of Nürnberg-Erlangen and IMF/FAD Panel expert. In his Blog Posting (in German) Vorschlag zur Schuldenbremse: Friss die Hälfte of February 10, 2009 http:// he is very much concerned about what he sees as an excessive and counterproductive fiscal discipline imposed by the new debt brake that, he fears, future governments may not be able to respect, given the spending pressures in an aging society. Also, the rule does not allow for debt-financed investment any more, even if it would make sense by all cost-benefit measures to undertake them.

He would have preferred a strategy that most Germans follow in order to loose weight: they do not change their behavior in a drastic way, but eat only half of what they used to eat. In the past 20 years, the share of the government budget deficit in GDP was of the order of 2.3 percent on average. If the government would follow this less stringent “Friss die Hälfte” strategy and cut net borrowing by half, Wigger has figured out that the debt/GDP ratio could over the long term fall to 40 percent, from its current level of 65 percent.

Neighboring Switzerland, where I was on an IMF mission earlier this year, introduced a debt brake similar to the German one not so long ago. There, it was just for the federal government, excluding the cantons---because most of 26 cantons had introduced their own debt brake long before. I heard many good things about the Swiss debt brake, when I was in Berne. The Swiss debt brake constrains expenditures so that nominal debt is stabilized over the cycle, which is even tighter than the German debt brake. In fact, the Swiss plan to tighten the debt rule even further, as they discuss to bring exceptional expenditures (currently excluded from the debt brake as in the German model) under the umbrella of the debt brake.