What comes after the end of the Merkel era?

Nadia Gharbi, Pictet Wealth Management

What comes after the end of the Merkel era?

With less than two months to go before the German federal election on September 26, polls are pointing to an uncertain outcome. Based on current opinion polls, the risk is that the next government will have to rely on a three-party coalition has increased. This could mean protracted coalition talks and a less ambitious government agenda. For the record, it took six months for a ‘grand coalition’ government made up of Christian Democrats (CDU/CSU) and Social Democrats (SPD) to be formed after the last elections in September 2017.

German and, to some extent, European economic policies in the coming years will depend a lot on the composition of the future government in Berlin. All of the major parties’ manifestos share ambitious climate goals—but with differences in the way each of them proposes to achieve these goals. Views are also wide apart when it comes to domestic and EU fiscal policy.

Although public spending in Germany caught up with levels in other big EU countries during the pandemic, and although many expect that it will want to exploit current low interest rates, the question is whether the September election will mark a more lasting shift in attitude regarding fiscal policy. Our view is that while we may see an expansionary tilt to fiscal policy, how far depends on the composition of the next government.

A two-thirds majority in parliament will be required to change the constitutional debt brake. Such a majority is unlikely to emerge after the elections. But an alternative way to increase public spending would be to create off-balance sheet vehicles. This would probably be the path of least resistance for conservative parties.

The German parties’ views on domestic fiscal policy are mirrored in their attitude towards EU fiscal policy. All parties agree on the need to reform the Stability and Growth Pact rules, but not all want to loosen them. While EU fiscal rules remain suspended until 2023 because of the pandemic, the European Commission is due to deliver a report on their reform by the end of this year. The German centre-right parties (CDU/CSU and FDP) have made clear that they do not want fiscal rules to be loosened. Yet a return to existing EU fiscal rules would mean countries on the EU periphery having to significantly consolidate their public finances, which could undermine the path to recovery. Conservative parties have also ruled out transforming the EU recovery package, Next Generation EU, into a permanent fiscal tool.

But all in all, while there are important divergences between the German political parties on fiscal policy, we see room for compromise.

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