Germany: Loosening the brake

Fiscal space under the debt brake is limited to some extra EUR5bn (0.14% of GDP) in 2020. In this light, we see the probability of a significant stimulus package beyond automatic stabilisers as low at the current stage.

Should the current economic downturn, against our expectations, develop into a deeper recession, a more relaxed stance towards the balanced budget policy and exceptions for green investments could be a first step towards looser fiscal policy.

An important bellwether for the timing, size and scope of fiscal measures will be developments in the German labour market.

In our view, softer fiscal policy will not ‘rock the boat' for funding and issuance until 2021.

As the German economy continues to be caught in the maelstrom of the trade war, calls for fiscal stimulus are growing louder. Still, the idea remains a contentious one, not only in policy circles but also among economists and the uncertainty centres mainly on whether the current slump is severe enough to warrant additional fiscal spending (see interview with Bundesbank President Jens Weidmann).

Without a doubt in our minds, the German economy is showing further signs of slowdown. Although the weak growth performance in Q2 was largely due to a slump in net exports related to Brexit stockpiling (see Chart 1), signs are also growing that domestic demand is feeling the pinch. Investment growth declined by 0.1% q/q in Q2 and, although private consumption held up, the big decline in retail sales in July by -2.2% m/m does not point to a strong rebound in Q3. With growth in key export markets such as China and the US slowing and uncertainty on the global political stage remaining prominent, we think it will be difficult for the German economy to avoid falling into a technical recession in Q3 In this light, we expect GDP growth in 2019 and 2020 to arrive at a meagre 0.5% and 0.7%, respectively – significantly below potential growth. Downside risks remain prominent, not least if US President Donald Trump makes true on his threat to impose car tariffs and Britain leaves the EU without a deal (see Brexit Monitor). As the ECB readies another stimulus package, we expect the effect of another rate cut plus QE restart to be miniscule in terms of real economy effects. What currently ails the Germany economy is mainly a lack of demand rather than too tight financial conditions and borrowing constraints for companies (see Chart 2). In this light, the uncertainty about the effectiveness and scope of fiscal stimulus bears closer inspection.

Looking back in history, the German government has shown a willingness to loosen its purse strings when faced with a significant economic downturn, as was the case during the Global Financial Crisis (GFC). In 2008 and 2009, the German government launched two fiscal stimulus packages (‘Konjunkurpakete') totalling some EUR73bn. Although the packages helped to counter the economic downturn, they also left sizable holes in state coffers, causing the debt to GDP ratio to jump to 81% in 2010 (part of the jump was due to significant bail-out packages for German banks such as Hypo Real Estate, Depfa and WestLB, which were funded by issuance of government bonds).

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