- Germany’s constitutional court ruled last week that the government’s move to reallocate emergency debt taken on during the pandemic to the current budget.
- This has left a €60 billion funding shortfall in the government’s budget, which is hitting climate policies particularly hard.
- The crisis has highlighted the divisions between the coalition partners and so far no immediate solution has been found.
German Chancellor Olaf Scholz (C), Finance Minister Christian Lindner (R) and Economy Minister Robert Habeck give statements to the media after the weekly cabinet meeting on November 15, 2023 in Berlin, Germany.
Sean Gallup | News from Getty Images | Getty Images
Germany’s budget is in trouble.
Last week, the constitutional court ruled that it was illegal to reallocate unused debt originally earmarked for emergency financing of the Covid-19 pandemic to ongoing spending plans.
This week, the Finance Ministry froze spending in all ministries.
But this may only be the tip of the iceberg, as financial problems could lead to political and even potentially jeopardizing the future of Berlin’s coalition government.
However, Germany did not get to this point overnight – in some ways, the roots of the current crisis even predate the pandemic. And this is because of Germany’s so-called debt brake.
Enacted in 2009, the debt brake limits how much debt the government can take on and dictates the maximum size of the federal government’s structural budget deficit. The rules state that it cannot be greater than 0.35 percent of Germany’s annual GDP.
Since the global financial crisis, the debt brake has been the cornerstone of German fiscal policy.
But then the Covid-19 pandemic happened. The government took on emergency debt to try to stem the impact of the pandemic on its budget through a temporary debt freeze.
As it turns out, the additional funding isn’t really needed. So the current coalition government decided to reallocate it to fund policies aimed at climate change and a greener, more sustainable economy.
The German opposition was not happy with the redistribution and eventually took the matter to the German Constitutional Court. The ruling came out last week and, in a blow to the government, the court confirmed that emergency funding is not allowed to be used for political plans unrelated to the pandemic.
The government appeared somewhat unprepared for the verdict and was left scrambling for answers when questioned by colleagues and the press.
Some observers (and a few members of the Green Party) suggest that the climate crisis is as much an emergency as the pandemic. But the court ruling stands and Germany’s budget now has a 60 billion euro ($65 billion) hole.
Since then, the government has struggled to figure out its financial plans, and earlier this week German media reported that the finance ministry had more or less ruled out any additional spending not yet planned for 2023.
A major factor in the government’s dilemma is the range of policy positions held by the three coalition partners.
There are the Greens, who were the prime movers behind the climate policy plans that are now at risk and therefore heavily attached to their success. Then the GSDP, the Social Democrats, who would be content to soften the debt brake or raise taxes. And the FDP, the Free Democratic Party, who control the finance ministry and don’t want higher taxes or higher debt.
But a total collapse of the government is unlikely, according to a research note published by Eurasia Group principals Jan Techau, Muytaba Rahman and Jens Larsen.
“The stability of the government is not in question and the coalition is likely to serve its full term,” they said.
“All three parties would face devastating losses in the (unlikely) event of a snap election, reducing their appetite for exiting the current arrangement.” No apparent new majority is possible in the current parliament,” they said.
Solutions are still few and far between, especially those that can be implemented in the immediate term, and the government is still working on plans to adjust spending and funding that coalition partners can agree on.
And in the long term?
“The obvious way out would be to change the constitution,” Berenberg Bank chief economist Holger Schmieding said in a note. That would require a new consensus with at least some of the opposition politicians needed to achieve the necessary two-thirds majority, he explained, which would mean political deals and sacrifices on divisive topics such as asylum rules.
“For now, such a deal seems unlikely. But after the next election in September 2025, a (new) government, which will again have to include parts of the center-right and center-left, may be able to make such a deal,” Schmieding said.
Reforming the debt brake after the next general election is also one path ahead that Citi economists Christian Schulz, Giada Gianni and Benjamin Nabarro foresee. They also note that long-term changes to the way the German government is financed may be coming.
“We expect the decision to lead the government to build real cash reserves in normal times as well as during emergencies, which would allow it to deal with the long-term effects of crises without violating the debt break,” they wrote in a research note.
Finally, the bar for what constitutes an “emergency” (and therefore allows the debt brake to be suspended) could be lowered — and eventually perhaps even include the climate crisis.
