German debt rules proposal fuels new austerity fear

By Jonathan Packroff
Apr 7, 2023
Languages: Deutsch

A German non-paper on the reform of European debt rules has been met with strong reactions from economists, who fear that the mistakes of the euro crisis could be repeated if the proposal is implemented strictly.

The paper comes in advance of the Commission’s legislative proposal to reform the EU rules for national budgets, the Stability and Growth Pact, which aims to make the rules governing public finances more realistic and enforceable. The proposal is expected later this month.

The German government had long been a critic of the reform, fearing that obligations for debt reduction could be loosened. It recently insisted on involving the member states one more time, before the legislative proposal is presented.

In a non-paper – an unofficial paper setting out the opinion of the government – sent to the European Commission earlier this week and seen by EURACTIV, the German finance ministry, led by Christian Lindner of liberal FDP party, reiterates this criticism.

After the reform, the EU rules should “lead to a (sufficient) decline in high debt ratios in each year from the start of the reformed fiscal framework on”, the paper reads. As such, the Commission’s current plans “should be amended”, it continues.

To achieve this goal, the paper suggests a minimum debt reduction (“common safeguard”) of 1% of GDP per year for highly indebted countries, such as Italy, and 0.5% for medium-indebted countries, such as Austria.

This would also mean letting go of an adjustment period of four to seven years, which the Commission’s reform proposal had foreseen for member states until their debt level had to be reduced year on year, intended to temporarily give member states more leeway for investments.

Mistakes of the past could be repeated

Proponents of a reform of the EU’s fiscal rules reacted strongly to the proposal.

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If implemented, the German proposal would be “catastrophic”, French economist Olivier Blanchard wrote on Twitter, adding that “it would lead to the worst form of pro-cyclical fiscal policy”.

This would mean that in an economic crisis, the country would have to drastically reduce its public spending, which could worsen the situation, explains Carl Mühlbach of FiscalFuture, a German NGO which aims to align fiscal policy with the interests of the young generation.

“When the economy is in a bad phase, the GDP is reduced, and the debt-to-GDP ratio rises accordingly,” Mühlbach told EURACTIV. “If you then still want to push down the debt ratio, you are forced to pursue an enormous austerity policy,” he added.

“This does not solve the debt problem, but makes it worse, because you then risk deepening the economic slump or recession,” Mühlbach said, adding that “this is what we had in the Euro crisis”.

The proposal would “echo” the old Stability and Growth Pact, René Repasi, member of the European Parliament for the German government party SPD (S&D), told EURACTIV.

“The past crises have just shown that this procyclical approach is outdated,” Repasi said.

He would, however, not go as far as calling it “catastrophic”, Repasi said, as this would be based on the assumption for the 1% annual debt reduction target to be a “hard, ex-post” criterion, which “does not seem to be clear on the basis of the paper, but would need to be clarified”.

However, “in the event of a crisis, a rule would have to be suspended again, as in the German non-paper”, Repasi said, adding that “that is precisely what we want to avoid with the reform.”

Start reducing debt now – or in 4 years?

Other experts, however, interpret the German proposal in a more favourable way.

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“Everyone is jumping on [the German proposal] as if the 1 percent is sort of a red line,” Sander Tordoir of the Centre for European Reform told EURACTIV.

“But if you read the paper, there’s a lot of ‘could’ and ‘could for example be’,” he said, adding that he thinks this language is chosen “explicitly and purposefully, signalling openness to discuss”.

In his interpretation, even in the view of the German government, the new rules will primarily focus on countries’ “net expenditure”, which means that in times of economic crisis, expenditure to stabilise the economy could still be done.

After national plans had been developed, “the leading guideline is this expenditure rule. So then the ‘debt safeguard’ is not the leading criterion,” he said, referring to the German proposal of a debt-to-GDP reduction of at least 1% a year.

The “real disagreement” between the Commission and Berlin would be whether the debt had to be reduced from day one, or only after four to seven years, as the Commission had proposed, Tordoir said.

“I think what Berlin is saying is that they want that [debt-to-GDP] ratio to already be declining during the four years,” he said. But given the current environment of high inflation and “normal” growth rates, this would not be unrealistic.

“If you are in a phase of higher inflation and growth is not great, but okay-ish, then a 1% nominal debt reduction, of the debt-to-GDP ratio, is doable, without having to go into austerity at all,” Tordoir said.

Germany wants same rules for all, not individual negotiations

The FDP’s Lindner had been a key opponent of the Commission’s proposal to reform the fiscal rules, arguing that it would give the Commission too much leeway in negotiating individual plans with member states.

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In its non-paper, Germany insists on “common quantitative benchmarks and common safeguards in the fiscal framework”.

“The political reality is that Berlin does not trust the Commission to be strict enough to enforce the rules,” Tordoir said.

Therefore, Berlin insists on measurable rules in numerical terms, applying to all member states.

But this had the disadvantage that countries’ individual situations could not be taken into account and would require a lot of estimates on the future economic development, Tordoir said.

“Codifying rules is very tricky because you don’t know what the economic environment looks like [in the future],” he said, adding that “we’ve had a lot of shocks, and we certainly don’t know what it looks like in five years”.

He, too, is no fan of the Commission’s proposal, as it included a “very weak” enforcement of the rules.

He would therefore prefer a “third way”, Tordoir said, which is “to give the Commission that discretion, but to have a much more robust set of enforcement instruments”. For instance, the payment of EU funds could be made dependent on compliance with fiscal rules.

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