Debt brake: How this fiscal rule could shape Germany’s election | Explainer News

As Germans prepare to vote on Sunday, their country’s sluggish economic growth will be top of their minds along with immigration and the Ukraine war.

A fiscal mechanism known as the debt brake, which strictly limits government borrowing, has become a fault line in German politics with the last government’s collapse blamed on the issue.

The world’s third largest economy shrank for the second straight year as its politicians are asking whether this fiscal straightjacket is hindering investment that could boost growth.

And while a significant number of potential voters remain undecided, Friedrich Merz’s conservative Christian Democratic Union (CDU) is the clear favourite to become the biggest party in parliament. The far-right Alternative for Germany (AfD) has made major gains in popularity in recent years on the back of an anti-immigration agenda, and polls put it in second place.

So what’s a debt brake, and why has it become a major election issue in the eurozone’s largest economy?

What is the debt brake?

The debt brake, or “Schuldenbremse”, caps the federal government’s new borrowing at 0.35 percent of Germany’s gross domestic product (GDP) – except in emergencies – and bars its 16 states from taking on new debt. It is designed to prevent irresponsible government spending.

It was introduced in 2009 under former Chancellor Angela Merkel in the wake of the global financial crisis. While the rule took effect in 2016, it was suspended during the COVID-19 pandemic and again after Russia’s invasion of Ukraine. The legislation was reinstated last year.

In her recent memoir, Merkel called for Germany to relax its debt brake in a sign of growing political pressure to overhaul a rule that many economists have said is too inflexible.

Germany has the lowest public debt of the large eurozone economies. In Italy, the government debt ratio equals 141 percent of its GDP. In France, it’s 112 percent. In Germany, it’s just 65 percent. In the International Monetary Fund’s (IMF’s) view, debt sustainability is not a pressing issue for Berlin.

And that reflects in the public opinion. Fifty-five percent of Germans now support upending strict borrowing limits, compared with 32 percent in July, according to a January poll by Forsa on behalf of the German Council on Foreign Relations.

Would the German economy benefit from more public investment?

Before this weekend’s elections, polls show that money is at the top of voters’ minds. And for good reason. Economic growth has been anaemic since 2019 and negative since 2023. Forecasters are also pencilling in falling growth for 2025.

Long considered a manufacturing powerhouse, Germany has struggled to fend off growing competition from China. Industrial work as a share of total employment has declined from 40 percent in 1990 to 27 percent today.

Germany’s sputtering industrial sector could be further hit by a potential trade war with the United States. Demand for its key exports – machinery, cars and industrial tools – fluctuates with wider global growth, which would fall in the event of higher global tariffs.

The country’s ageing transport, energy and housing infrastructure also needs upgrading.

Elsewhere, Berlin spends 2.1 percent of its GDP on defence, a touch above NATO’s annual target. But that is thanks to a 100-billion-euro ($105bn) fund created for the war in Ukraine. The fund is expected to run dry by 2027, and Berlin will face tough questions on how to meet its NATO obligations without breaking its fiscal rules.

To make matters worse, Germany’s population is ageing. The number of people older than 64 is projected to grow by 41 percent to 24 million by 2050, accounting for nearly one-third of the population. The ratio of working to retired people will fall, which will lead to a shrinking tax base.

Concerns about the strength of Germany’s economy have also undermined private investment, which is further contained by elevated corporate tax rates.

Still, the debt brake has inhibited successive governments from large-scale spending projects. Public investment has remained stable at about 2 to 3 percent of GDP in recent years, which is low compared with other countries in the region.

The upshot is that Germany’s motorway authority has identified 45 billion euros ($47bn) of investment needs, there is a nationwide shortage of 800,000 homes and the stated aim of achieving net-zero carbon emissions by 2045 will require tens of billions of euros of extra spending every year.

Addressing Germany’s numerous structural challenges will cost about 600 billion euros ($628bn) by 2030, according to the German Economic Institute.

Many economists are calling on the government to leverage its fiscal wiggle room to boost output.

“Any serious efforts to fundamentally reform and improve the German economy will have to come with fiscal stimulus,” Carsten Brzeski, global head of macro research at the Dutch bank ING, told clients in a note.

He added: “Finding the fiscal space for all the required policies exclusively in austerity looks like a mission impossible.” As such, any new government “will have to agree on looser fiscal policies [i.e., relaxing the debt brake],” Brzeski said.

Why is it such an important election issue?

The debt brake was largely behind the collapse of the governing coalition in November. Chancellor Olaf Scholz pushed for it to be suspended in the draft budget to pay for additional spending in Ukraine. But this was resisted by Finance Minister Christian Lindner from the coalition partner Free Democratic Party (FDP). Lindner was later dismissed.

With no party set to win a straightforward majority in Sunday’s elections, coalition talks are likely to drag on for months. The new government’s first priority would be to agree on budgets for this year and 2026.

While Merz, the clear frontrunner to become chancellor, has promised to “uphold” the debt brake, he has also left the door open for change.

“Of course, it can be reformed,” Merz said. “The question is why, for what purpose.” He said he won’t pursue extra borrowing for more welfare spending. But if extra borrowing were to boost investment “then the answer may be different,” he said.

Broadly, the liberal FDP, the conservative CDU and the far-right AfD want to cut government red tape, reduce welfare benefits and preserve existing fiscal rules. On the flipside, left-wing parties, such as Scholz’s Social Democratic Party (SPD) and the Greens want the debt brake to be relaxed and for public investment to rise.

According to Shahin Vallee, a senior research fellow at the German Council on Foreign Relations, “the economic slowdown has taken a toll on the political situation.”

Many commentators believe that years of low growth and simmering economic frustration are partly responsible for the rise of the anti-establishment AfD.

What is the future of Germany’s debt brake?

Germany’s central bank has long called for tweaks to the fiscal mechanism that would permit small increases in borrowing. Most pundits expect only a limited relaxing rather than a complete overhaul of the borrowing cap.

But even that won’t be easy. Any change to the rule would require a two-thirds majority in both the upper and lower houses of parliament. The AfD, which blames low growth on environmental regulations and mass immigration, opposes fiscal reform as does Lindner’s FDP.

Although Merz recently passed anti-immigration legislation with the AfD’s backing, he has refused to form a coalition government with the party, which is expected to win 20 percent of Sunday’s vote.

As such, Merz will have to form a coalition with one or two of the parties in Scholz’s government, the SPD and the Greens, which are polling in third and second place before the elections.

One possibility would be for the SPD and the Greens to condition their entry into a coalition with Merz on him agreeing to remove certain spending items – notably on climate change-linked investments – from the brake altogether.

For Vallee, debt brake reform is now firmly “on the table … as there is a growing consensus in Germany that fiscal policy will have to be amended. I think deep down, Merz is secretly happy to be forced into higher public spending by a [left-wing] coalition partner.”