German budget crisis will haunt economy for years

LONDON, Nov 24 (Reuters Breakingviews) – The German government is working hard to demonstrate the foolishness of the country’s iron-clad ban on large budget deficits. It now says it will suspend the “debt brake” after the Constitutional Court forced it to cancel some 60 billion euros worth of fiscal spending that it had included in a 210 billion euro climate and transformation fund. But the welcome relief is only temporary, and the harm is done. The budget crisis will cripple the economy for years to come, for three reasons.
The first is that the strife will lead to an austerity programme in a shrinking economy. The debt brake, which limits structural budget deficits to 0.35% of GDP, has only been suspended for this year’s budget. What matters is the 2024 budget, and there the discussion has been delayed.
To suspend the debt brake, the government must claim some form of emergency. Covid-19 was one, but climate change may not fit the definition. The government is considering higher taxes – such as increased levies on carbon and inheritance. Cuts to subsidies decided to help businesses or households weather the energy crisis are also on the agenda. Overall, the drive to bring the budget back under control will affect growth next year, the Organisation for Economic Co-operation and Development noted.
Secondly, the economy will also feel the impact of prolonged uncertainty, both legal and economic. Businesses will struggle to predict which type of public aid will come their way to both cushion the energy crisis and invest in the climate transition. That points to the risk of lower private investment. Meanwhile concerned households will tend to save more, notes ING economist Carsten Brzeski.
Finally the most serious risk for Germany’s long-term prosperity would be lower public investment, in a country that has deployed much less than the rest of Europe for decades. That’s a time when Berlin needs to beef up its public investment by 450 billion to 500 billion euros in the next decade, according to the German Economic Institute. Public net investment has been negative for 20 years, Marcel Fratzscher, head of the German Institute for Economic Research, has pointed out. The irony is that lower future growth would then lead to a higher debt-to-GDP ratio.
That metric stands at around 66% of GDP this year and was predicted to shrink to 64% in 2024, compared to the 90% euro zone average. The country is not on the cusp of a debt crisis. But it has arrived at a point where it must pay an economic price for its fundamentalist approach to fiscal restraint.
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CONTEXT NEWS
German Finance Minister Christian Lindner said on Nov. 23 that he would propose a supplementary budget for 2023 which will include the suspension of limits on new borrowing. “In consultation with the chancellor and the vice chancellor, I will present a supplementary budget for this year next week,” Lindner told reporters.
Lindner is trying to ease a budgetary crisis caused last week by Germany’s Constitutional Court ruling, which blocked the transfer of unused funds from the pandemic to green investment, blowing a 60 billion euro hole in its finances.
“We will now put spending, especially for the power and gas price brakes, on a constitutionally secure footing,” he said.
Yields on Germany’s 10-year bonds rose 9 basis points, to 2.66%, on Nov. 23.
Editing by George Hay and Streisand Neto
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