Germany’s post-pandemic budget will reverberate beyond its borders

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Germany’s new budget and medium-term spending plan, announced last Wednesday, come at a doubly difficult time. Both in Germany and at the EU level, what should post-pandemic fiscal policy look like is becoming an increasingly pressing question.

Berlin’s budget plans are sending a signal on how Europe’s largest economy will deal with this issue, although they are unlikely to survive this fall’s election in their current form.

“This is certainly not the last word… A new government will want to leave its own footprint on the budget for 2022,” says Katharina Utermöhl, senior economist for Europe at Allianz. But the budget “highlights the difficulty to move from a tax version of ‘whatever it takes’ to a fiscal status quo, ”she adds.

As part of the plans, which include a 2022 budget and fiscal and spending forecasts for 2023-2025, the emergency suspension of Germany’s debt brake – the strict limit on new borrowing enshrined in the German constitution – continues next year. “We have to do this to have a sound fiscal policy,” says Philippa Sigl-Glöckner, director of the Dezernat Zukunft think tank and former head of the finance ministry.

The suspension allows the government to borrow around 100 billion euros next year. But in 2023, the deficit should fall to less than 10 billion euros to respect the debt brake. This will happen just as “growth projections are running out of steam and unemployment remains higher than before the pandemic,” warns Sigl-Glöckner.

The planned tightening might not be as drastic as the numbers suggest. The debt brake rule does not take into account borrowings classified as involving a notional “pool” of money previously budgeted but not spent. Berlin’s plans to spread these drawdowns on reserves over the next few years mean that true macroeconomic consolidation is all the softer.

Despite these sleight of hand, the centrality of the rule in political planning and rhetoric means that with concerns about debt overshadowing how to invest in the carbon transition, “you are not focusing on what matters. is important ”, explains Sigl-Glöckner.

And things will be “painful” from 2023, warns Utermöhl. The government’s repayment schedule for Covid-related debt then goes into effect and becomes much more demanding from 2026. It will be “difficult to find enough room to invest” despite the looming challenges of green and digital transitions, says it.

What does this mean for the euro area? According to Utermöhl, the country’s delay in fiscal consolidation “short-term aid by controlling budget divergences” between states like Italy, which could cause “fiscal madness”, and Germany, which could “set the tone eurozone fiscal policy ”if it began to normalize.

It also highlights the implications for monetary policy. Apart from emergency pandemic debt purchases, the ECB has pledged to hold only a limited share of each country’s total debt. A sharp reduction in German debt issuance “could see the European Central Bank encounter debt limits” in its regular asset purchase program.

Sigl-Glöckner is also concerned about the signal Germany’s leadership is sending about the looming debate over EU fiscal rules that limit member states’ deficit spending – which are also on hold until next year . “If Germany tells you that by 2023 it’s back to the rules, you had better start consolidating,” she said.

The Ministry of Finance stresses that federal investment spending is expected to amount to more than 50 billion euros per year, more than a quarter more than before the pandemic. And with luck, growth may be strong enough to reduce the deficit without too much fiscal effort.

The risk, however, is a “hard landing” in 2023, says Utermöhl, both “for fiscal policy. . . and for the [tax and spending] promises that will have been made ”in the electoral campaign.

Despite all these warnings, German policymakers have locked themselves into the politics of rules. “Most politicians still think that you don’t win an election when you openly criticize the debt brake,” says Sigl-Glöckner.

The exception is the Greens who want to reform it – so “it will be interesting to see how the Greens are doing,” she adds.

But whether the election challenges or consolidates Germany’s conventional wisdom, the consequences will matter far beyond its borders.


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