If fiscal rules are further relaxed, the sustainability of public finances will decrease. Financial policy uncertainty in Germany and Europe is increasing.
From the outset, the Basic Law contained regulatory limits that were intended to prevent political abuse of the national debt to the detriment of future governments. Limiting debt took on additional significance with the creation of the European Monetary Union in 1999. It creates a fundamental conflict of objectives between national and European stability, which causes “free-rider behavior”: individual countries become more indebted because the stability of the currency is not only depends not only on our own, but also on the financial policies of other countries. Therefore, limits on national debt were agreed. The current debt rule of the Basic Law (“debt brake”) also serves to ensure compliance with European regulatory limits.
After four years of emergency, the current year will see a return to the standard limits of the Basic Law. With the exception of the so-called economic component, this means that the federal and state governments have to set up largely balanced budgets.
Actually, the return to rule-based financial policy should be unproblematic. The corona epidemic is history, the energy crisis of 2022 has been overcome and independent funding has been secured for the upgrading of the Bundeswehr by changing the Basic Law. However, German financial policy still planned for significant deficits. However, they should be outsourced to special households (“special assets”). In this way, the aim was to circumvent the regulatory limits of the Basic Law.
Despite the warnings from experts, this risky financial policy was hardly raised in public until the Federal Constitutional Court ended the outsourcing of deficits from the core budgets in mid-November 2023. This has thrown the federal government in particular into difficulties, as the financial flexibility created by the bypass is part of the coalition agreement. In particular, it was planned to cushion the serious economic consequences of the energy transition policy through state subsidies. In various federal states, there was also a focus on absorbing deficits in extra budgets bypassing the debt brake.
Accordingly, financial policy uncertainty has increased significantly and it is currently not clear how the requirements will be met. Given the many challenges facing politicians, it is not surprising that formal limits on debt are criticized by some as a crucial obstacle to sound financial policy. In particular, it is argued that Germany’s debt level of around 64% of economic output in 2023 is low in international comparison. The long-term sustainability of the national debt in Germany is not at risk, as recently concluded by the Council of Experts for the Assessment of Overall Economic Development and therefore spoke out in favor of easing the debt rules in Germany.
This rating is surprising. The European limit is lower at 60% and the financial planning presented in the autumn does not foresee a reduction in national debt. The federal government has now also published the Sixth Sustainability Report, which diagnoses a significant sustainability gap. The report updates the current financial policy in the long term, taking social insurance into account. According to the results, the debt level would increase dramatically even in a favorable scenario without massive consolidation measures.
Although there are considerable doubts about the long-term sustainability of public finances in other European countries, there are currently plans at the European level to relax fiscal rules. In future, the national cyclically adjusted deficit will no longer be subject to an upper limit of 0.5% of economic output (“Medium Term Objective”), but rather a limit of 1.5% (“Deficit Resilience Safeguard”). The states should also design their financial planning in such a way that a path for reducing national debt is laid out. However, the specific definitions are unlikely to be very effective, as they are to be developed through bilateral negotiations with the European Commission, which will then pursue further political goals.
But the more the rules are relaxed now, the more urgent the question of long-term sustainability will become. It is therefore expected that there will continue to be a high level of financial policy uncertainty in Germany and Europe in the coming years.
Notice: The article appears as an editorial in issue 5 (2024) of the journal Knew.
Friedrich Alexander University Erlangen-Nuremberg
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Guest article Financial policy uncertainty due to erosion of fiscal rules
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2024-04-26 21:26:12
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Abu Dhabi Commercial Bank’s credit rating affirmed at A1 by Moody’s, showing steady recovery