Economists recommend reform of Germany's debt brake as energy price effects recede

The German economy is emerging from its downswing slower than expected and will likely only achieve minimum growth of 0.1 percent in 2024, a joint analysis by five leading research institutes has found. Falling energy prices mean these are losing in relevance for the growth prospects, while a “mild” reform of the country’s debt brake could help put the economy on a more solid footing in the long run, the economists found.

In 2025, Germany’s GDP growth could attain 1.4 percent, they said. A combination of short-term and structural effects is keeping the economy in check and the researchers expect private consumption to be the driving force for GDP growth soon, not least thanks to a robust labour market and low unemployment. Consumption is aided by falling energy prices, which means the rate of inflation slows to 2.3 percent this year (2.8% if energy is not taken into account). However, energy prices continued to weigh on the competitiveness of energy-intensive German companies in recent months and exports are expected to only pick up again next year, the analysis found.

“Economic output is currently at a level that is barely higher than before the pandemic. Since then, productivity in Germany has been at a standstill. There have recently been more headwinds than tailwinds in the domestic and foreign economies,” the researchers concluded, pointing out that a lack of planning security is dampening investment activity. The research institutes recommend a careful reform of the country’s national debt brake, which has thwarted the government’s 2024 spending plans following a constitutional court ruling at the end of last year. Based on a proposal by Germany’s central bank, the economists recommend a gradual return to deficit rules after an exceptional emergency is declared, as was the case in the coronavirus pandemic, as well as allowing more debt-financed investments. After reaching 2.1 percent of GDP in 2023, the debt ratio is expected to drop 1.6 percent in 2024 and 1.2 percent in 2025.

"A rule-based recalibration would take the aftermath of adverse shocks into account and act as a stabilising factor thanks to better predictability of financial policy,” they argued. Moreover, this could factor in developments that are directly linked to the energy transition and are sensitive to economic development, such as carbon pricing and renewable power support. However, while “restrained modifications” to the debt ceiling appear expedient, “it does not determine the prosperity of Germany as an economic location,” the institutes said.