German fiscal stimulus, can we believe it?

It appears that a German fiscal stimulus is not imminent and that these effects would take time to materialize. Maintaining a budget surplus target while the Eurosystem will start buying German bonds again from November will maintain downward pressure on German long-term interest rates.

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In Germany, GDP fell by 0.1% in the second quarter after expanding by 0.4% in the first quarter of 2019. Year-on-year GDP growth slowed sharply to 0.4% and the Bundesbank reports the risk of coming into recession in the 3rd quarter in its August monthly report. It predicts that the industry, which has been in recession since mid-2018, will continue to suffer in the 3rd quarter and that exports will continue to contract. The German industry is particularly affected by the trade war and the consequent slowdown in world trade, but also by the Brexit and the drop in exports to the United Kingdom, as well as the difficulties faced by the automotive sector. The IMF and the European Budget Council have pleaded for years for Germany and the Netherlands to use the fiscal margins they have to invest. With the current difficulties of the German industry, the debate is gaining ground in Germany.

In Spiegel, August 24, 2019, It’s Time for Germany to step up, columnist Mathieu Von Rohr concludes that it is time for Germany to turn the page of perfectly balanced budgets, and invest and innovate more. The German Industry Association (BDI) urges the government to invest in education and infrastructure, particularly in digital. It also invited herself to the debate on the partial cancellation of the Soli Tax this summer in order to demand its total abolition. Olaf Scholz, finance Minister, said Germany had enough fiscal space in case of need.

If the debate on the possibility of a fiscal stimulus is raised in Germany and should result in announcements in the coming weeks or months, oppositions in principle, differences of opinion on its nature and very strict German budgetary rules could delay its implementation and greatly limit its scope. We detail in this text the terms of a possible stimulus package plan, starting by recalling the conditions under which the stimulus package plan was decided during the 2008-2009 recession.

A fiscal stimulus that was already late in the 2008-2009 Recession

During the Great Recession of 2008-2009, the decision to launch a fiscal stimulus package in Germany was not quick. Germany officially entered recession on November 13, 2008 (contraction of GDP in Q2 and Q3 2008), that is, about two months after the collapse of Lehman Brothers, which triggered a very sharp rise in risk aversion in financial markets and jeopardized the stability of the global banking system. At the time, the urgency of Western governments was mainly to stabilize the financial and banking situation. On this point, Germany’s reaction was swift as Angela Merkel announced on October 6 that the government would guarantee all bank deposits and that the Bundestag had approved a plan to support banks by € 500bn. The creation of a stabilization fund called Sonderfonds Finanzmarktstabilisierung had the aim to guarantee for debt instruments of eligible financial institutions for an amount of € 400bn, € 80bn for recapitalizations of banks and € 20bn to mitigate any losses. On the other hand, nothing was officially planned yet to boost growth.

It is from the end of October 2008 that a stimulus package from Germany has been more and more often mentioned in the press. Although the principle appeared to have been acted upon by the government at the time, dissension between the two coalition parties (CDU and SPD) over the content of the stimulus package delayed its adoption. The CDU favored tax cuts to support consumption and SPD public investments to support directly businesses. The German government agreed on November 5, on the first version of the stimulus package, that only covered € 12 bn over two years (0.25% of GDP) and was heavily criticized ... On November 13, The Economist magazine published one of its articles: "A little stimulus: Even in recession, Germany is the last of the small spenders" and mocked the smallness of the program while China and Japan in particular were embarking on stimulus packages of several hundred billion dollars.

Then, the idea was to coordinate budgetary stimulus at the European level. This was not immediately a success. Angela Merkel and Nicolas Sarkozy failed to agree on a coordinated VAT cut on 24 November. On 26 November, the EU countries agreed at a European Council on an "immediate budgetary impulse" of around €200 bn euros (1.5% of GDP), without knowing which countries would contribute and on what timetable. For example, Spain announced € 11bn in additional infrastructure spending on November 27. Italy announced € 5 bn in additional spending on 28 November. France announced on December 4 a stimulus plan of € 26 bn (1.3% of GDP, 11.6 bn in support of corporate treasury, 10.5 bn public investment). But the German government announced what Angela Merkel presented as "the most important economic recovery in the history of the Federal Republic", amounting to € 49.25 bn over two years only on January 13, 2009. The plan included € 17.3 bn in infrastructure investment, tax cuts and social contributions of € 9 bn, a scrappage bonus, an increase in family allowances and measures to encourage part-time unemployment rather than job cuts.

Among the elements that had overcome Angela Merkel’s hesitations, there is the very sharp deterioration of the "expectations" component of the Ifo survey in October, November and December 2008 and the explosion of short-term contracts numbers. However, it is interesting to note that at the time and despite the circumstances, Finance Minister, Peter Steinbrück, was dubbed the "record debt minister" by the liberal-democratic FDP party. This aversion to public debt pushed, as we will see, the adoption of rules limiting deficits in the future.

Which are the most restrictive budgetary rules for Germany?

For Germany, the European fiscal rules are not a constraint, since the country already complies with the deficit to GDP rule (below 3%) and with the debt to GDP rule (below 60%). The German rules, introduced in the constitution following the Great Recessions of 2008, restrict the use of borrowing.

The "debt brake" (Schuldenbremse) has been included in the German constitution (Article 109) since 2009. It provides that the government seeks a balanced budget (Schwarze null) and that the structural deficit of the federal budget will be limited to 0.35 % of GDP as of 2016. As for the 16 German "Länder" which are competent in infrastructure management, education or the environment, they lack financial means and are not entitled to recourse to debt for their operating expenses. They have been granted additional time until 2020 to apply this balanced budget rule.

Definition The structural balance represents the budget balance corrected by the effects that could be attributed to the economic cycle and one-offs. It therefore corresponds to the budget balance when GDP growth is at its potential. Differences in the assessment of the structural balance are related to the difficulty of assessing the potential growth of a country.

There are, however, conditions for derogating from this balanced budget rule since the Bundestag can declare an "emergency" in case of natural disaster or serious recession. However, the current situation could not justify it according to the proponents of the budgetary orthodoxy. It would require a more marked deterioration of the economic situation to allow it and notably the proven entry into recession, materialized by two consecutive quarters of negative GDP growth.

As for the abandonment of the "debt brake", it would require an amendment to the German Constitution, which requires a two-thirds majority in the Upper House and the Lower House of Parliament (Bundesrat and Bundestag).

What might be the modalities, timing and scale of the fiscal stimulus?

According to estimates by the European Commission, the German budget for 2019 already includes 0.3% of GDP, or nearly €10 bn of fiscal stimulus, mainly new investment and social spending. It should also be slightly expansionary for 2020 when referring to the Stability and Growth Pact.

In its latest Article IV report of July 2019, the IMF’s first recommendation to the German authorities is to make better use of the fiscal space at its disposal to support long-term growth. The European Commission also calls for increased public investment in education, research and infrastructure. It also suggests improving relations between the Federation and the Länder in order to allow an adequate level of investment. The IMF estimates Germany’s additional fiscal space at 1% of GDP in the medium term, ie € 30 bn. The European Budget Council (EFB) has the same assessment.

Reluctance has already been expressed at the highest level on the very principle of a fiscal stimulus, by Chancellor Angela Merkel who ruled that "the time has not come yet" or by Jens Weidman, the President of the Bundesbank who considers that we should not "sink into actions or pessimism" while stating that in the event of a recession, fiscal rules offer additional means of action. Finance and Economy Ministers Olaf Scholz and Peter Altmeier appeared more open on this topic. Olaf Scholz raised a budget of € 50 bn in mid-August to make budgetary stimulus if necessary.

A first salvo could be considered with a limited scope given the constraints on the structural deficit that we mentioned earlier. It nevertheless offers the possibility of making an additional plan of nearly € 30 bn.

A new salvo could be put in place invoking the emergency if the recession was confirmed after the publication of the GDP growth figure in the 3rd quarter, that is to say end of October. It would theoretically exceed 0.35% of structural deficit GDP and launch a large-scale support plan.

It has also been envisaged to go through public agencies and private law foundations to make investment, particularly in the fight against global warming. The expenditure of these agencies or foundations has the advantage of not being included in the federal budget and is therefore not subject to the very binding German constitutional limits. On the other hand, they enter into the European budget calculations which leaves more room for maneuver.

If the principle were accepted, how could this fiscal stimulus be applied?

Beyond the very principle of fiscal stimulus, the debate also focuses on the nature of the measures envisaged, lower taxes and / or increased investment spending? This summer, the gradual abolition of the solidarity tax “Soli tax” has already been announced by the government. This 5.5% tax on income and profits was introduced in 1991 to facilitate the reunification process. The current project aims to eliminate it for 90% of the people who are subject to it in 2021, which would represent a tax reduction of about € 20 bn per year. Whereas the BDI association demands its complete removal, other voices would like this waiver to be cancelled because some tax revenues may be lower than expected due to the economic downturn.

Tax deductions to encourage businesses to invest are also discussed. For households, measures to help acquire less polluting cars would help both a struggling industrial sector (modeled on what had been put in place in 2009 and which had worked well) and to promote the reduction of CO2 emissions.

Capital expenditure is also considered necessary with several priority sectors: digital development, expenditure on the education system, transport infrastructure and social housing, while real estate prices have risen considerably during the last 10 years. A € 2.4 bn digital investment plan was implemented in the summer of 2018 with the aim of improving digital access in schools and broadband in Germany. Nevertheless, the European ranking of the Digital Economy and Society Index ranks Germany 12th out of 28 countries which proves that there is still room for further investment in this area. Finally, a climate and infrastructure plan is requested by the Social Democrats. The climate forum in late September could be an opportunity for announcements in this area.

In conclusion, it appears that a German fiscal stimulus is not imminent and that these effects would take time to materialize. Maintaining a budget surplus target while the Eurosystem will start buying German bonds again from November will maintain downward pressure on German long-term interest rates.

Bastien Drut , Juliette Cohen September 2019

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