Germany Grapples with Budget Crisis, Sparks Calls for Debt Brake Reform

The debt brake restricts a government's structural budget deficit to 0.35% of gross domestic product (GDP), even as the demand for increased spending rises.

Germany’s budget crisis has ignited a fresh push for reforming the country’s self-imposed borrowing limits, even among opposition conservatives, as the imperative for much-needed investment takes precedence over prior fiscal conservatism.

A recent ruling by Germany’s constitutional court on November 15 threw Chancellor Olaf Scholz’s coalition government into disarray when it declared a budget maneuver to bypass the nation’s “debt brake” as unconstitutional.

This decision indicated that both Scholz’s administration and future governments must adhere more closely to the spirit of the debt brake.

The debt brake restricts a government’s structural budget deficit to 0.35% of gross domestic product (GDP), even as the demand for increased spending rises.

Concerns are growing among business and political leaders that Berlin will struggle to finance responses to pressing challenges, including climate change and the conflict in Ukraine.

Chronic underinvestment in Europe’s largest economy has contributed to its current stagnation, leading economists to call for reform of the debt brake.

Even conservative politicians, who initially opposed reform, are now considering it, especially those in power at the state level grappling with the consequences of the court’s ruling.

Billions of euros in state subsidies promised to U.S. chipmaker Intel for planned plants in Saxony-Anhalt, crucial for Germany’s transition to a carbon-neutral economy, are now in limbo.

Germany’s underinvestment has already amounted to around 300 billion euros over the past decade compared to other AAA-rated economies, according to Scope Ratings.

To reform the debt brake, a change to the constitution is required, necessitating a two-thirds supermajority in parliament, which appears challenging to achieve at this stage.

While some, like Federal CDU leader Friedrich Merz, insist on maintaining the debt brake, others have come to recognize the need for reform.

Berlin Mayor Kai Wegner stated on social media that the debt brake could potentially become an impediment to the future.

The debt brake was introduced in 2009 with bipartisan support following the global financial crisis and the European debt crisis.

However, it has been suspended since the onset of the COVID-19 pandemic in 2020 to finance the country’s response to the crisis.

Subsequent crises have forced Germany to rely more on off-budget funds, even as interest rates have risen.

The court ruling on November 15 has signaled that Germany may need to adhere more closely to the debt brake’s principles in the future.

ING Chief Economist Carsten Brzeski emphasized that as circumstances change, so should debt brake policies.

As Germany grapples with its fiscal challenges, the need for debt brake reform is becoming increasingly apparent, with proponents of reform growing more vocal within Scholz’s SPD and other political parties.

Conservatives are cautious about reform, fearing it could lead to fiscal laxity both at home and in Europe.

Some propose targeted solutions, such as exempting military investments and support for Ukraine from the debt brake.

The issue is expected to become more pressing for conservatives by the 2025 federal elections, and cooperation between Germany’s traditionally strongest parties, the SPD and conservatives, may be necessary for any reform.

The pace of reform remains uncertain, given the need for a supermajority in parliament.