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

The German Bundesbank has introduced a comprehensive three-phase proposal aimed at reforming the country's constitutional debt brake, a measure designed to maintain fiscal discipline while allowing greater flexibility for public investments. This initiative comes as calls to modernize the debt brake intensify, with both major political parties seeking to balance investment needs with long-term debt sustainability.

Framework for Reform

The Bundesbank's plan sets out a structured timeline for changes, beginning with the continuation of current relaxed debt rules through 2029. These temporary provisions, introduced to meet pressing fiscal demands such as defense and infrastructure, permit higher deficits than originally stipulated by the debt brake. In this initial stage, the government can leverage additional borrowing to support significant national priorities.

From 2030 to 2035, the Bundesbank envisions a transitional period in which deficit spending would gradually decrease. The aim during this phase is to bring budgetary practices back in line with European fiscal standards, specifically the EU's Stability and Growth Pact. Defense expenditures, which have been partly financed through credit, would increasingly need to rely on regular budget allocations rather than new borrowing.

The third phase, commencing in 2036, introduces revised and more stringent fiscal rules. At this point, the Bundesbank recommends that the federal government be permitted a fixed borrowing limit of 0.8% of gross domestic product (GDP) specifically for tangible investments. This would institutionalize a dedicated investment budget and help stabilize funding for infrastructure projects independently of short-term fiscal fluctuations.

Variable Borrowing Limits Tied to Debt Levels

A key component of the Bundesbank's proposal is the introduction of a variable borrowing framework tied to the national debt ratio. If Germany's public debt remains below 60% of GDP--the threshold established by EU Maastricht criteria--the federal and state governments would each retain a borrowing capacity of 0.35% of GDP. Should the debt ratio surpass this level, the permitted borrowing would be reduced to 0.1% of GDP for both tiers of government. This adjustment is intended to ensure alignment with European fiscal obligations and to impose stricter discipline if debt levels rise.

Supporting National Investment and Compliance with EU Standards

The Bundesbank's proposal seeks to strike a balance between enabling crucial investments in areas such as infrastructure, defense, and climate protection, and upholding the principles of fiscal responsibility. The federal government has already established special funds, including those for infrastructure and climate initiatives, which are exempt from the current debt brake and can be financed with up to 500 billion euros in additional borrowing. However, these exceptions have been subject to debate, prompting the call for a more transparent and predictable fiscal framework.

Embedded in the German constitution, the debt brake restricts the government's capacity to incur new debt, yet its practical implementation has faced criticism for being either too rigid or too permissive, depending on economic conditions. To address these concerns, a government-appointed commission is currently reviewing the debt brake and is expected to issue reform recommendations in the near future.

Broader Fiscal Context

Germany's fiscal policy is also influenced by broader European Union requirements, which mandate that member states maintain public debt below 60% of GDP and deficits under 3%. The Bundesbank's reform plan is designed to ensure that future German budgets are compliant with these standards, while also providing scope for essential investments that support economic growth and national security.

By proposing a phased approach with clear borrowing caps linked to economic performance and European obligations, the Bundesbank aims to provide policymakers with a stable and predictable fiscal environment. This is intended to safeguard Germany's long-term financial health, meet EU commitments, and support sustainable public investment.