Before the financial crisis struck, the German finance minister Peer Steinbrück had a very ambitious goal. He wanted to enter history books as the finance minister who managed to oversee the first federal budget in Germany without new borrowings in a generation.
This dream is now shattered. As the Financial Times Deutschland pointedly remarked a few weeks back, Mr. Steinbrück is now entering history books as the finance minister who has overseen the largest federal budget deficit ever: With the government’s stimulus package of about €50bn, the German government is now set to borrow as much as never before in euro terms.
Yet, this might not be all what historians will remember Mr Steinbrück for: This week, the Föderalismuskommission, a joint commission of the German government and the German Länder has agreed on severely limiting public borrowing in the future (the “Schuldenbremse”). The German Länder (the federal states) will be totally prohibited from running budget deficits from 2020 onwards. The federal level will have its annual public borrowing restricted to 0.35 percent of GDP. Exceptions will only be granted for economic fluctuations (while the technical details ar enot yet clear), natural desasters and deep recessions. The rules will be written into the German constitutions, so that future generations of politicians can only change them with very large majorities. The blueprint came right out of Mr Steinbrück’s office who had pushed the idea for almost two years now, even if some details have been changed.
In effect, Mr Steinbrück has thus managed to give Germany the strictest public anti-borrowing legislation of any large OECD countries. While Mr Steinbrück himself might see this as a success, it is hard to find pleasure in the rules if one takes economic reason as the benchmark.
First, the rule does not allow for debt-financed investment, even if it would make sense by all cost-benefits measures to conduct them. What makes sense for every company and every household – to borrow for an investment that yields higher returns that the interest rate on the loan – is in future prohibited by the government.
Second, the rule does not distinguish what the money borrowed is used for: It does not make any difference whether the minuscule government borrowing still allowed will be used on government consumption or transfers (i.e. for pensions) or for projects that might yield large economic returns in the long run (such as spending on education).
Third, if one sticks to the borrowing limits and assumes that the German economy will grow by a nominal rate of 3.5 percent per year (2 percent inflation plus 1.5 percent real growth), the public debt level will over time fall to around 10 percent of GDP. There is no reason to expect any benefits from such a low level of debt. Instead, this level might be even too low to support a liquid government bond market for Bunds. German savers are thus deprived of their possibility to invest in risk-free domestic bonds.
Fourth, the rule might just be too strict and might prevent the government from reacting to future economic crisis in due time. Already in this current crisis, the German government with its federal structure and complicated arithmetics of the Grand coalition has been extremely slow to pass the stimulus package (the largest part of the package will only come into effect in the summer of 2009, when the German economy will have shrunk for five consecutive quarters). With the new rules of required super-majorities to override the new debt-rules, this reaction lag will only grow larger in the future.
It is very hard to understand that the same group of politicians which has just observed that former doctrines (such as that of superiority of unregulated financial markets or that of the ineffectiveness of fiscal policy) might change very quickly and that flexibility is sometimes needed is now writing their own doctrines on public debt into the constitution to bind the hand of the next generation of politicians.
Thus, even if Mr Steinbrück sees his work of the past year now as a success (mainly thanks to the constitutional amendment), I am afraid that future historians and economists will evaluate him much less favorably. It is true, as Mr Steinbrück has argued in a Spiegel interview, that he is not making the same mistakes as Heinrich Brüning (the chancellor in the Weimar Republic who ruined the German economy by his austerity packages in a deep recession). However, one does not need to be a Brüning to enter history books as a finance minister with little economic competency. A “Schuldenbremse” as it now looks to be passed is enough to qualify a finance minister for this path into the history books.
This post has been co-posted at Eurozone Watch.