Fiscal Turbulence in Germany: the Budget Crisis and Its Broader Implications

Germany is currently grappling with a significant budget crisis, posing challenges for Chancellor Olaf Scholz’s government and raising concerns about the potential impact on various policies and the economy at large.

The crisis emerged in mid-November when the German constitutional court ruled that the funding for the 2024 budget, announced in July, was not legally sourced. The government’s plan involved redistributing €60 billion from emergency coronavirus measures to the “climate transformation fund” (KTF). This decision has created a €17-billion shortfall in the budget, prompting urgent deliberations among key political figures, including Scholz, Finance Minister Christian Lindner, and Minister for Economic Affairs and Climate Action Robert Habeck.

Central to the crisis is Germany’s debt brake (Schuldenbremse), limiting the government’s borrowing to no more than 0.35 percent of GDP. Introduced in 2009 to stabilize the economy post-financial crisis, it has recently become a contentious point. While Lindner has indicated that 2023 will be an “emergency year,” allowing an override of this limit, he has ruled out the same for 2024, sparking fears of impending austerity measures.

The budget shortfall threatens several policies, notably the climate transformation fund initiatives. Already, the government has announced the discontinuation of the gas and electricity price cap from December 31, 2023. This policy, capping energy prices to aid households post-Ukraine invasion, will lead to increased costs for consumers. Furthermore, planned renovations of Deutsche Bahn railway tracks and subsidies for electric car purchases are at risk.

A study by Germany’s Institute for Ecological Economic Research warns that failing to adequately address climate change could cost the country up to €900 billion in economic damage by 2050. In contrast, timely policy implementation could reduce this to €280 billion.

The budget crisis has elicited varied responses across Europe. Some, recalling Germany’s previous stance during financial crises in other EU countries, view the situation with a mix of irony and concern. For instance, suggestions like those made during Greece’s financial struggles, such as asset sales, have resurfaced in a different context.

The crisis has also put the spotlight on Germany’s fiscal practices, which were once considered exemplary in Europe. Critics within and outside Germany have suggested that the rigid adherence to fiscal rules might be outdated, especially considering the string of crises faced in the 2020s.

A key difference between Germany’s situation and scenarios like the U.S. government shutdown is the provision in the German Basic Law (Grundgesetz). It allows the government to maintain operations even without a timely budget, preventing a complete halt of governmental activities.

The economic ministry forecasts that not utilizing the funds from the climate and transformation fund and the Economic Stabilization Fund (WSF) could reduce Germany’s GDP growth by up to 0.6 percentage points.

As the German government works to navigate this fiscal challenge, the broader implications for the EU economy and Germany’s role in it are becoming increasingly apparent. The outcome of these budget negotiations will not only shape Germany’s domestic policies, particularly in climate action and social security, but also influence its economic stability and position within the European Union.