Budget policy: How economists want to reform the debt brake

The debt brake is in need of reform - says not just anyone, but the Council of Experts for the Assessment of Overall Economic Development, in short: the economists.

Budget policy: How economists want to reform the debt brake

The debt brake is in need of reform - says not just anyone, but the Council of Experts for the Assessment of Overall Economic Development, in short: the economists. The five-member expert council proposes a revision of the clause anchored in the Basic Law in three places.

Specifically, the committee advocates, for example, the introduction of a “transitional phase for the years immediately after the application of the exception clause of the debt brake”. It sounds complicated, but it just means that the federal government can give itself more time to finance external shocks. An example of this would be the corona crisis. It required massive government spending, which activated the debt brake's exception clause.

Until now, the debt brake would have to come into effect more or less immediately as soon as the special situation ends. Economists suggest extending this period to avoid a kind of cold turkey. During this time, the permissible structural deficit is likely to be above the normal limit, but the debt would have to be steadily reduced.

The second point is to make the control limit more variable. Currently, a maximum of 0.35 percent of the gross domestic product (GDP) can be taken out annually in the form of new loans. The economists suggest that this value be staggered more closely depending on the debt ratio.

In times of low debt ratios, the standard limit could be higher. If the debt ratio is below 60 percent of gross domestic product (GDP), the limit for the structural deficit should be one percent of GDP, and if it is between 60 and 90 percent, it should be 0.5 percent. Only then, when the national debt ratio is over 90 percent, would the old limit of 0.35 percent come into effect. This would mean that Germany would orient itself much closer to the European rules, which allow structural deficits of 1 percent of GDP below the 60 percent limit. In the future, this should even be 1.5 percent.

As a third proposal, the committee wants to methodically improve the economic adjustment. It is currently vulnerable to revision, which makes it more difficult to achieve a financial policy that is more in line with the economic situation. The federal government is currently measuring how the economy is doing using the so-called production gap. This defines the percentage deviation between GDP and potential production.

The problem here is the production potential, which is defined as “production volume at normal capacity”. This quantity cannot be observed, but can only be estimated in real time. However, this is extremely susceptible to fluctuations. Which economist knows from his office how many cars VW can produce at this moment? This can only be determined after a financial year.

As a consequence, these incorrect estimates lead to revisions. This means that either too much debt is allowed or too little, "with undesirable effects on overall economic demand," the economic experts write in their statement. It is true that revisions cannot be completely avoided. But, the experts write, “modern econometric estimation methods could reduce revisions to potential output and the output gap.”

One idea would be an “error correction component”. Simply put, this would mean that incorrect estimates and revisions in individual years are not so significant, but can instead balance each other out over time. This reduces the pressure for budget politicians to act. However, this is explicitly not intended to "structurally expand the scope for debt, but rather to better reflect the economically necessary financial requirements at the time of drawing up the budget," said council member Martin Werding.

Nevertheless, the proposal is clearly aimed in one direction: “The adjustment to the debt brake we propose increases the flexibility of fiscal policy,” said Council Chairwoman Monika Schnitzer. “It makes it possible to undertake forward-looking public spending and manage the transition after an emergency without undermining the sustainability of public finances.”

The proposal is largely praised in the economist community. The economist Rüdiger Bachmann, who teaches in the USA, explained on X that the proposal was heading in the right direction. He will publish a similar draft very soon.

The Düsseldorf competition economist Jens Südekum and Marcel Fratzscher, President of the German Institute for Economic Research (DIW), also consider the proposals to be fundamentally sensible. The two are rarely close in terms of economic policy, but they have one point of criticism that points in the same direction: Südekum and Fratzscher miss earmarks. Not all debts are the same, they say. If, for example, new debt were taken out for investments, that would be better than if it were used to finance government consumption. The proposal does not sufficiently make this distinction.

This article first appeared in the business magazine "Capital", which, like stern, is part of RTL Deutschland.