German Chancellor-elect Friedrich Merz has announced the likely lifting of the "debt brake" that prevents a sharp increase in the country's military and infrastructure spending. According to his plan, the government will spend an additional 1% of GDP on defense spending, as well as create a fund of 500 billion euros for the implementation of infrastructure projects. The sensational program, however, will not be easy to execute. Even if it can be passed through the Bundestag, a sharp increase in borrowing could cost Germany double and damage its EU neighbors, as the debt market hinted immediately after Merz's remarks. Details can be found in the Izvestia article.
Slowed down for 11 years
Germany is an atypical country in terms of public finances. Like Moscow, Berlin is extremely skeptical about the build-up of public debt. As a result, government debt is less than 60% of GDP, which is one of the lowest rates among EU countries. For comparison, the debt of neighboring France is about 110%, and in Italy it is 135%. Regardless of the dominant parties, German governments strive for a balanced budget.
This diligence is largely due to the mechanism of the "debt brake". It provides for a ban on a structural budget deficit (that is, a new debt without taking into account payments on the old one) in the amount of 0.35% of GDP. The mechanism was introduced in 2009 at the constitutional level against the background of the catastrophic situation with the global financial crisis, it reflects the skeptical attitude of the Germans towards increasing debt.
In the following years, nothing changed, despite the European debt crisis, Brexit, the massive influx of refugees in 2015 and other major events that affected the economy. From time to time, the German budget was even reduced to a surplus, which is almost unthinkable for large economies in our time (with the exception, again, of Russia, which has its own remote analogue of such a mechanism — the budget rule).
The mechanism worked for 11 years, and then failed. The coronavirus pandemic led to the fact that the German government declared an emergency, under which it was allowed to temporarily ignore the "brakes", provided that the funds received would be used to eliminate the consequences of the epidemic.
In the following years, the emergency situation was consistently updated, even when covid receded. The last time this happened was in 2023, and the funds raised in this way were supposed to go to help Ukraine. The German Constitutional Court, however, had a different opinion and forbade the use of this loophole for other purposes. The government, which was experiencing a crisis of legitimacy, could not do anything about it — it was necessary to change the Constitution.
Today, Merz and his party intend to eliminate this obstacle in principle. The situation looks ironic, given that the CDU/CSU is a fiscally Conservative party, whose ideology contains provisions on respect for public finances and distrust of the growing debt burden. Although the Conservatives plan to rule together with the Social Democrats, who will be junior partners in the coalition, such an initiative from them was quite unexpected.
A half-trillion dollar political maneuver
Not everyone in Germany is positive about both the increase in spending in principle and specifically spending on military tasks. The figure of 500 billion euros looks fantastic. In addition, Merz and his team intend to increase military spending by issuing additional debt by 1% of GDP, or by an additional €50 billion per year.
It should be noted that the country has been in recession for two years in a row — this has almost never happened. Industrial production has been in negative territory for almost 30 months due to a sharp rise in the price of energy resources, mainly caused by the severance of trade relations with Russia. Government stimulus for the economy in this situation is becoming a very promising way out of the crisis. Especially against the background of the military panic that began to take hold of the high offices of the EU countries.
The problem is that in order to cancel or adjust the "debt brake", the Constitution needs to be changed, which means that two-thirds of the votes in the Bundestag must be collected. In the past, when 3-4 parties entered parliament, of which the CDU/CSU and the SPD were absolutely dominant, this was not so difficult to do. Especially if the main players came to a consensus.
But now the political field is much more fragmented: five parties have broken into the Bundestag, two of which are considered "anti-systemic," and the CDU and SPD together barely exceed 50% of the vote, despite the fact that previously it was common for them to control 70-80% of the seats. The attitude in society towards the proposed measures is also not the most unambiguous.
In order to clear this hurdle, the proposed coalition will have to negotiate with either the "Left" or the "Alternative for Germany" (AfD), but neither of them will rush to put their signature on such a vote. The AFD, in principle, does not approve of the expansion of debt financing, and the "leftists" do not like military spending. Both require active participation in government, especially the AfD, which is now the largest opposition party.
There is another way to pass the law. To do this, you can reconvene the old parliament and vote there. The weight of the AfD and the "Left" is much lower in its composition, so that the system parties will be able to gain the two-thirds of the votes they need quite easily if they agree among themselves. Such a maneuver, although completely legitimate, has problems with legitimacy. In fact, it turns out that the new coalition has ignored the will of the people, and this may become a problem even a few years before the new federal elections.
Panic in the markets
On the one hand, the plan looks flawless. Germany has been limiting itself for decades and now has an excellent reserve for increasing public debt. In this mode, in theory, it is possible to increase funding for a decade or even more and not experience any difficulties. But practical execution can cause problems not only for political reasons.
Immediately after the initiative was announced, German debt securities collapsed, and their yields, on the contrary, jumped. On Wednesday, it rose 0.3 percentage points to 2.83%. This leap was the largest since 1989, since the fall of the Berlin Wall. On Thursday, March 6, yields continued to rise, eventually reaching 2.93%. All this means that the cost of borrowing for Germans has already increased — and these rates can become a serious obstacle in building up debt.
The upheavals in the German market have caused a domino effect around the world, which has worsened the situation. Italian bonds, for example, fell by 4%. The decline in quotations occurred throughout Europe. This is to be expected: after all, if Germany borrows more, the demand for securities from other European countries will decrease. The market is not rubbery, and the creditworthiness of France or Italy is highly questionable compared to Germany. The domino effect was not limited to Europe: on the same day, government debt quotes fell in Japan and even in Australia and New Zealand.
In addition, it should be borne in mind that the main problems of Germany in particular and Europe as a whole are not so much a lack of money as a lack of resources. A large—scale program of re-equipment and infrastructure construction - worth a trillion euros or more — will require a sharp increase in their consumption.
Meanwhile, high commodity prices have already caused industrial stagnation in European countries. The rapid growth in demand will lead to an additional jump in these prices, especially given the gap between Europe and Russia. All this may lead to a new round of inflation and, as a result, another economic crisis, although Europe has not yet recovered from the consequences of the current one.
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