Bundesbank Proposes Three-Phase Plan to Overhaul Germany's Debt Brake

The German central bank has introduced a comprehensive strategy aimed at reforming the country's fiscal policy rules, specifically the debt brake, to provide more flexibility for public investment while maintaining fiscal discipline. The proposal addresses ongoing debates among political leaders regarding the need for modernization and additional spending in areas such as defense, infrastructure, and climate protection.

The plan, outlined in a detailed policy document, calls for a three-phase approach to reform. The initial phase, extending to 2029, would maintain the recently relaxed debt brake provisions. These measures currently allow for higher government deficits to support increased expenditures on defense and critical infrastructure projects.

Following this, the second phase from 2030 to 2035 would serve as a transitional period. During these years, the central bank recommends a gradual reduction in government deficits to align with European Union fiscal requirements. In this phase, defense expenditures would increasingly be financed without additional borrowing, reflecting a shift towards more stringent fiscal management.

The final phase, commencing in 2036, introduces stricter borrowing guidelines. The Bundesbank suggests establishing a fixed borrowing capacity of 0.8 percent of gross domestic product (GDP) specifically for additional capital investment, regardless of the prevailing debt-to-GDP ratio. This framework would effectively institutionalize special funds for infrastructure, ensuring a stable source of investment financing.

Furthermore, the proposal introduces a variable borrowing limit contingent upon the national debt level. If the federal debt remains below 60 percent of GDP, the existing borrowing allowance of 0.35 percent of GDP for both the federal government and the states would continue. However, should the debt ratio exceed the 60 percent threshold established by EU Maastricht criteria, this borrowing limit would be reduced to 0.1 percent of GDP for both federal and state governments. This mechanism is designed to reinforce compliance with European fiscal standards and promote sustainable public finances.

The German government has committed to substantial borrowing in the coming years to fund investments in defense, infrastructure, and environmental initiatives. A dedicated special fund for infrastructure and climate protection has also been established, which operates outside the constraints of the debt brake and is authorized to borrow up to 500 billion euros. Despite the constitutional cap on government borrowing, these exceptions have drawn criticism and prompted calls for a more durable and transparent fiscal framework.

To help shape the future of fiscal policy, a government-appointed commission began its review of the debt brake earlier this year. This body is tasked with formulating recommendations for a long-term reform that balances the need for investment with the imperative of fiscal sustainability, taking into account both domestic and European financial regulations.

The Bundesbank's proposed plan seeks to offer a balanced solution that supports essential government investment while safeguarding the integrity of public finances. By introducing phased adjustments and linking borrowing capacities to economic indicators and EU criteria, the plan aims to ensure fiscal stability and adaptability in a changing economic landscape. The recommendations are expected to influence ongoing political discussions and the work of the reform commission, setting the stage for potential legislative changes in the coming years.