I was wondering if you would consider writing a post about the German debt brake in light of recent developments? Personally, I am not a huge fan of discussions about fiscal policy (or even worse, austerity…), as I feel they are mostly Rorschach test without much deep thinking. But I did find the recent developments intriguing because they challenge my priors so I am wondering what whether your thinking has changed as well.

My prior was that some form of constitutional debt break is a reasonable mechanism to deal with the pro-debt bias resulting from democratic political process. Of course, some of the recent German experience has challenged that. For example, debt break legislation lead to a lot of “bad” legislating, which was exposed by the court recently. Similarly, the debt break is leading Germany to cut spending and increase taxes relative to what the government would want; given the weakness in German economy this does not seem like optimal fiscal policy (but might be – monetary policy by choice restrictive, and many have called on fiscal to be too). And more broadly, there is a fair argument to be made that it has constrained government investment during last decade, which was an optimal time to do government investment given the negative interest rates.

Part of this I think is a question of imperfect design/implementation. The deficit threshold of -0.35% is higher than I would imagine. Absence of any relationship to current interest rates or effect on future debt levels ala CBO analysis is probably not what finance theory would suggest. And the cyclical adjustment seems suspicious: my understanding is that currently the cyclical adjustment allows for 0.1% of GDP of extra deficit, corresponding to 1% output gap and 1/10 elasticity, see here.[1] But I suspect imperfect design/implementation will always be a feature of these kind of legalistic rules, so should not be waved away.

At the same time, I find lot of the commentary rather subpar. I have in mind for example arguments in this article. While I can see that investment would likely be higher last decade in absence of debt break, saying that debt break results in “Germany that doesn’t invest and massively falls behind in economic terms” is just shocking, as it implies that investment can be only done through higher deficits. Moreover, arguing that debt break has to be abolished so that Germany can invest to deal with geopolitics and green transition is simply ignoring that Germany already found a legally-sound solution to such kind of problems when it constitutionally created its 100 billion euro defense spending fund. Together with the wise use of debt break suspensions during last 4 years this shows that there is sufficient flexibility built into this, despite what the commentators would suggest (“but in practice it’s too inflexible”), as long as there is consensus on such actions. But maybe this points towards the actual problem: maybe in current society building political consensus has become too hard, so that mechanisms which rely too much on such consensus are doomed to create more problems than their benefit. The US debt ceiling comes to mind. Similarly, I think CDU secretly agrees with some of the governments desires, but will not act on them either because it wishes for the government to collapse or is afraid of voters’ reaction.

Very curious what is your thinking and how it has changed.

Kamil

P.S.: Relatedly, I often see left-of-center economists citing IMF research that austerity does not yield decrease in government debts relative to GDP. While I understand the value of such research, I am not sure what are the people suggesting. If austerity cannot lower debt to GDP, what can? I don’t think that most economists would suggest that large scale government investment is going to lower debt to GDP. So it the conclusion that we can never lower debt to GDP?

Kamil expands on these points in a blog post, concluding:

So maybe this is the main critique of the constitutional debt break: In the older world it might have been an good tool, but given the general unravelling of political process around the world, it adds too much of a constraint leading to worse outcomes. It simply is not fit for the current times. It might not be. As for me, I am currently in state of “not sure”.