Thread by @tom_krebs_

Many economists (including myself) have asked the German government to use the available fiscal space to increase public investment. In this Thread, I argue that the federal government has almost no fiscal space left unless the constitution (Grundgesetz) is changed.

Germany has a balanced-budget rule (Schuldenbremse) enshrined in its constitution that allows for a cyclical-adjusted deficit of 0.35% of GDP – about 12 bil Euro in 2019. After the cyclical adjustment and adjustment for “investment funds”, this number is reduced to 5 bil in 2019.

So, this is the current fiscal space of the German federal government in 2019, and about the same in 2020, if it narrowly follows the current German law: 5 billion Euro or 0,15% of GDP! Can we enlarge the fiscal space further within the current legal framework? Yes and no.

First, most people agree that the technique used to implement the cyclical adjustment needs to be changed since it makes the fiscal rule pro-cyclical. For example, despite 2 quarters of near zero growth the method reduces the available fiscal space by 4 bil. Euro in 2019.

I am strongly in favor of thinking and implementing a better method for computing the cyclical adjustment. However, Germany is currently using "the" EU-method and the issue should therefore be resolved at the EU-level, even if it takes a bit longer.

Second, if the government creates legally independent public companies the government outlays used to finance these companies are not counted when computing the deficit according to the German balanced-budget rule, though they are counted according to the European fiscal pact.

This generates in principle additional fiscal space since the EU fiscal pact allows for a budget deficit of 0.5%, respectively 1% if the debt-to-output ratio falls below 60%. This possibility is currently discussed in policy circles, but I have some reservations.

I fear this viewed by some as an attempt to circumvent the German balanced-budget rule using “accounting tricks”, which undermines credibility. I do not necessarily support this view, but I am sure that many critiques will make these charges, and they have a point. Why?

In general, I think the credibility argument has been over-used in German policy discussions and has often been used rather arbitrarily to push a particular political agenda. However, the situation is different in this case: The balanced-budget rule is part of the constitution!

This puts the discussion at an entirely different level than merely discussing promises some parties might have made in the past. In his case, we have a (pretty bad) policy rule written into law. In addition: Germans like their rules and they like to interpret them very narrowly!

So, when I weigh the long-run cost in terms of possible reputation damage with the short-run benefits of generating a bit more fiscal space, my preference is not to go down this slippery slope. Instead, I’d rather focus on changing the fiscal rule in our constitution.

Interestingly, the Green Party has just published a policy note in which they propose a debt-financed public-investment agenda, and they also argue that constitutional change is the best solution to finance the additional investment spending:

gruene.de/artikel/in-die…

Also of interest, reforming the German balanced-budget rule to allow for debt-financing of public investment has been on the political agenda of many Social Democrats, including a group of members of congress:

vorwaerts.de/artikel/spd-wi…

So, things are moving in the right direction in Germany and perhaps in the future there is a political majority for constitutional change and we can replace the balanced-budget rule with an economically more sensible fiscal rule. @sven_kindler @CanselK @RyglewskiS @mischrodi