Financial policy must free itself from the debt trap

What to do with the debt Regardless of whether Olaf Scholz or Armin Laschet moves into the Chancellery after Sunday’s elections, the answer to this question will shape Germany’s financial and economic policy for years to come. The answer must come by 2023 at the latest, when the statutory debt brake, which was suspended during the pandemic to save Germany from the virus, will come into force again.

And in the United States this week, Congress is grappling with the question of whether to raise the national debt ceiling to prevent the government from defaulting and President Joe Biden to publicize his $ 4.5 trillion in infrastructure and social spending.

Many say that at least in Germany we can save ourselves a new debt debate. The debt brake introduced after the financial crisis in 2009 has constitutional status and can only be changed with a two-thirds majority in the Bundestag. Neither the FDP nor the Union are ready and rely on the widespread discomfort in this country to live on credit.

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On the other hand, all major parties in Germany have promised massive investments in the coming years in view of the climate crisis and the enormous financial requirements for public infrastructure. Even if some of it can be mobilized from private sources, the state will not be able to step on the gas and step on the debt brake in the fight against climate change and digitization at the same time. Especially not if tax cuts are also promised.

However, both sides of the debt debate are not just about financial mathematics, but deeply moral issues as well. The conservative supporters of an economical budget policy do not want to burden future generations with mountains of debt. Proponents of a loosening of the debt rules counter that we have to invest now if we do not want to leave our children a ramshackle country marked by climate disasters.

Permanent crises are the new normal

In addition, there are some indications that the pandemic was not the last crisis that we had to fight with all our might. New viruses, floods, droughts and other natural disasters as well as geopolitical conflicts and migration crises could become our constant companions. So it is quite possible that the permanent state of emergency and not the old normality is the “new normal” that we have to be prepared for.

This is one of the reasons why the economic environment surrounding the debt debate has changed. Who would have thought that the financial markets would shrug their shoulders and take note of debt levels of well over 100 percent of GDP in the US and more than 70 percent in Germany and that government bonds would be given negative interest rates instead of higher risk premiums?

“Whatever it takes”, the famous promise made by former ECB boss Mario Draghi in the fight against the euro crisis, has become the new mantra of international crisis management. And markets, which used to be a whip for budget discipline, seem to tolerate that, at least for the moment. “The greatest risk is not to take too much money in hand – it is to take too little money in hand,” says US President Joe Biden.

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Balance between debt brake and getting into debt

Are thrift, sound housekeeping and debt rules therefore a thing of the past? Can we spend as much money in the future as if there was no tomorrow – or at least no rude awakening the morning after? Not at all.

Debt rules stem from a healthy distrust of the weaknesses of human nature. Trust is good, control is better – we have done well with this principle, especially in financial policy. In the future, too, we will need stop signs when it comes to getting into debt. However, they must no longer be our only guide. In addition to do’s and don’ts, financial policy also needs positive goals that go beyond debt ceilings.

Of course, Biden’s warning is political rhetoric. But there is also the truth that not only incurring excessive debt entails great risks, but that you can also save at the wrong end. The digital desert, the educational emergency, but also the slow climate change in the state and economy are examples of this. This is precisely why Michael Hüther, head of the German Economic Institute (IW), which is close to the employer, suggested that productive investments should be excluded from the debt brake.

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The previous fiscal rules also have the structural disadvantage that they only ever look at the mountains of debt of the past in the rear-view mirror. Former US Treasury Secretary Larry Summers, who is quite critical of Biden’s spending policy, has therefore proposed a forward-looking interest rate. For Germany, an interest rate indicator for the increase in financing costs in the budget could be an alternative to the debt brake.

The task of the new federal government will be to rebalance the risks of the debt brake and getting into debt. Future financial policy must not only apply the brakes, it must also create room for maneuver.

More: Climate economist Stern warns against insisting on EU debt rules: “We must not make these mistakes again”

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