The German government could take on just under €2tn in debt over the next decade without running the risk of damaging growth, according to a Financial Times analysis of a Eurozone economists poll that supports likely-chancellor Friedrich Merz’s fiscal bazooka.
An economists’ poll conducted last week estimated that Europe’s largest economy could raise its fiscal burden from its current level of 63 per cent of GDP to 86 per cent of GDP over the next decade without negative repercussions. The 28 economists’ responses imply fiscal space of €1.9tn.
“Germany has a large fiscal capacity,” said Marcello Messori, a professor at the European University Institute, Florence, adding that the space to create more debt should be used to push Germany’s and the wider European economy towards “high-tech sectors and an effective green transition.”
The findings come after Merz, head of the centre-right Christian Democrats, and his likely coalition partner, the Social Democrats, on Tuesday unveiled plans to boost the country’s creaking infrastructure and raise defence spending.
Economists anticipate the much-needed fiscal bazooka, which follows more than five years of economic stagnation, could lead to an additional €1tn in public borrowing over the next decade.
“The key point”, said Jesper Rangvid, professor at Copenhagen Business School, who estimated that the manageable debt level stands at 80 per cent “or perhaps 90 per cent”, was that Germany had “room to borrow responsibly”, to pay for urgently needed rearmament and infrastructure improvements.
“Critical infrastructure, such as the notoriously inefficient rail system and more generally its infrastructure, also digital infrastructure, must be upgraded,” he said.
The FT calculations of the €1.9tn in fiscal space assume that German nominal GDP will increase by 2 per cent per year from €4.3tn to €5.4tn by 2035. This estimate is likely to be conservative, as it does not account for any real GDP growth, should inflation match the European Central Bank’s 2 per cent target.
Many participants stressed that the additional borrowing needed to be combined with structural reform to raise the country’s productive capacity.
“money alone will not solve the challenges,” said Ulrich Kater, the chief economist of Frankfurt-based Deka Bank.
Willem Buiter, former chief economist of Citi and adviser at Maverecon, described the German economy as “grotesquely over-regulated”.
On Saturday, the likely coalition partners outlined further policy details that clash with economists’ calls.
Instead of cutting red tape and unleashing sweeping pro-growth reform, the likely coalition instead promised new state benefits — including higher pensions for non-working mothers, a cut in VAT for restaurants, and a reintroduction of fuel subsidies for farmers.
Bert Flossbach, co-founder of German asset manager Flossbach von Storch, said ahead of the announcement on Saturday that the new government’s flexibility to spend big on defence could create “more room to increase social consumption and inflate the welfare state even further”.
Lorenzo Codogno, founder and chief economist of LC Macro Advisors, said that Germany’s “real problem” was its model that has prevailed over the past 20 years and was dominated by “sophisticated but old industries”. Germany also needed “leading-edge, innovative companies”, he said.
“German industries are stuck in a middle technology trap” and the country needed to “modernise” its manufacturing, said Antti Alaja, an economist at the Finnish Centre for New Economic Analysis.
Stefan Hofrichter, an economist at Allianz Global Investors, blamed the country’s stifling bureaucracy and tax regime, saying that the economy was dragged down by “too rigid bureaucracy” and “too high corporate taxes” which were both “contributing to private under-investments.”
Jörg Krämer, the chief economist of Commerzbank, urged Merz to dial back the state’s influence over the economy and to “trust the citizens and the corporates” instead in a push for “better business conditions”.
The findings were based on 28 quantitative responses given to a question on whether, leaving aside any legal borrowing limits, Germany could raise its federal debt without repercussions on growth.
A widely-cited 2010 study by Kenneth Rogoff and Carmen Reinhart suggested that debt exceeding 90 per cent of GDP harms growth, but subsequent research has challenged this conclusion.
“The economic literature does not provide a definite answer on the appropriate level of public debt,” said Isabelle Mateos y Lago, group chief economist at BNP Paribas, adding that debt dynamics driven by nominal growth and borrowing costs were more important.
All of the 41 economists who responded to a question on Germany’s strict debt brake, which locks in additional spending at 0.35 per cent of GDP, said the borrowing rule, in place since 2009, should be eased.
More than a quarter — or 29 per cent of respondents — said it should be completely abolished, which 41 per cent or overhauled to provide “a lot more flexibility”. The remaining economists supported a moderate reform to introduce “a bit more flexibility.” No one called on the rule to be left unchanged or harden it.
“[The] German obsession with fiscal prudence is overdone and reforms are overdue,” said Martin Moryson, global head of economics at German asset manager DWS, adding that the incoming government had “obviously” understood the “magnitude of the task and stands up to the challenge.”
However, lawmakers for the Green Party said on Sunday that they opposed, in their current form, Merz’s plans to create fiscal space through moving defence spending above 1 per cent of GDP outside of the debt brake.
Their opposition could thwart the plans, which require changes to Germany’s constitution and a two-thirds majority in the parliament’s upper house, the Bundesrat, to pass.
Data visualisation by Oliver Roeder in London
