The issue of government spending and debt brakes, combined with the alleged risks of excessive government debt, is on everyone's lips. The debates on the Federal Budget 2024 and, not least, the ruling of the Federal Constitutional Court on the Climate and Transformation Fund of November 15, 2023, have shown: the current fiscal framework comes from a different time and seems unable to meet the challenges of today and tomorrow. The urgently needed money seems to be lacking on all fronts. What lies behind this?

The way in which government spending or government debt is limited, and to what extent, has strong effects on our daily lives as well as on our future prospects and the lives of younger generations. It is clear that "[a] sustainable fiscal policy cannot be guided by the fear of government debt, but invests in our future" (Mühlbach, 2022). The fear of excessive government debt in Germany is not only disproportionate. In fact, the current legal limitations on government debt are fictitious. They are not based on reality but on myths that are not economically sound and will be debunked below. At the same time, such rigid boundaries complicate dealing with the most formative challenges and multiple crises of our time. The current debt brake has turned out to be a brake on investment and a brake on the future.

Therefore, the question arises as to what limits there are on government debt instead. What is scarce if not money? What real conditions of our economy, society, and planet do actually limit government debt? This article invites the readers to a critical examination of the current limits set on government debt and contributes to the debate on the urgently needed design of a sustainable fiscal policy.

The legal limits of government debt are fictitious

Limiting government debt as an absolute value makes little sense in principle. The so-called "debt clock" by the Association of Taxpayers in Berlin indicates the absolute level of government debt in Germany. When you stand in front of it, you can observe how the digital display changes steadily. However, the absolute level of government debt is not very meaningful. The currently legally applicable limits on government debt, whether it is the debt brake or other fiscal rules like the EU framework for economic governance, aim to limit public debt in relation to the gross domestic product (GDP). The so-called government debt ratio (short: "debt ratio") therefore indicates the ratio between government debt and the nominal GDP of a country. In this way, the level of public debt is accordingly given in percentages (%).

At the European level, the Stability and Growth Pact (SGP) regulates that member states must limit their annual budget deficit to 3% of GDP and their debt to 60% of GDP, i.e., to a debt ratio of a maximum of 60%. These are the so-called Maastricht criteria. In addition, the SGP obliges adherence to the so-called medium-term budgetary objective (MTO). With a debt ratio of over 60%, a maximum structural deficit of 0.5% of GDP is allowed. The structural deficit is intended to exclude cyclical factors that depend on the economic period or cycle of a country, i.e., whether there is an upswing or recession. With a debt ratio of less than 60%, a structural deficit of 1% of GDP is permissible. For understanding: The aforementioned 3% from the Maastricht criteria refer to the overall government financing deficit, i.e., they refer to both structural and cyclical factors.

In Germany, the 0.5% is divided into 0.35% for the federal government (+/- cyclical component) and 0.15% for the federal states, with these waiving "their share". Thus, the structural government debt or net borrowing for the federal government is limited to 0.35% of GDP. This "debt brake" is anchored in Article 109 of the German Constitution (Federal Ministry of Finance, 2022). This implies that the expenditures budgeted in the federal budget must be almost entirely covered by previously "earned" revenues, especially tax revenues. In the event of natural disasters or extraordinary emergencies beyond the control of the state that significantly affect the state's financial situation, the German Parliament can decide to suspend the debt brake. For example, the debt brake was suspended during the Corona pandemic, and the upper limit for structural net borrowing was exceeded. Since 2023, it has been reinstated, and many necessary expenditures must now be financed from so-called shadow budgets.

The fact that these national and European debt brakes consider government debt in relation to GDP is usually economically justified but not economically sound. The following part explains why the need for rigid debt-to-GDP ratio limits, justified by economic relationships, does not correspond to empirical evidence. Thus, the often-cited justifications for the existing debt limits turn out to be myths. A debt ratio of a maximum of 60% as a general criterion for the so-called debt sustainability of a country is not very sensible when considering that the level of the debt ratio has a very different meaning and significance depending on the economy. Another outdated argument is that a low debt ratio limits inflation and thus ensures price and financial stability. The example of Japan with a debt ratio of 261% in 2022 illustrates that this line of argument is not supportable in reality.

The idea that inflation arises from an increased money supply is a myth based on the "quantity theory of money." According to this theory, a higher money supply, distributed over an unchanged number of goods, leads to higher prices for individual goods. However, at least in the crises of recent years, the opposite has been shown: On the one hand, inflation rates remained low despite expansionary monetary policy following the "whatever-it-takes" logic. On the other hand, the current inflation is not directly related to the money supply but to our fossil dependencies (cost-push inflation) combined with dysfunctional markets (sellers' inflation) (Kraken et al., 2023). Higher government debt itself only becomes inflationary if it finances inflationary expenditures; otherwise, it does not. Apart from that, the debt ratio has also not proven to be an indicator of the level of financing costs. Amidst a low-interest-rate environment, the government debt of the EU-27 has risen since 2019 (Federal Agency for Civic Education, 2023). Far from any economic foundation, the 60% debt ratio at the time of the adoption of the SGP was the then-average of the debt ratios of the member states.

The economic justifications for the described limitations of government debt are coming to their limits. At the same time, they have far-reaching consequences, as debt and investments are essentially two sides of the same coin. Behind low debt levels, there are currently significant investment backlogs that threaten to emerge as obstacles to the future, especially for younger generations. It is clear that the transition from a fossil-based economy to climate neutrality and all other challenges related to socio-ecological transformation entail substantial financing needs. These needs add to the already substantial investment requirements in Germany. Furthermore, further postponing these investments into the future - to comply with fictitious limits - is associated with even higher costs, such as climate-related costs (Flaute et al., 2022). These costs will be particularly felt by younger generations. Therefore, it is essential to revise the currently applicable, fictitious limits of government debt and to align them with real circumstances or to "adjust the legal scope of debt issuance to the economically sensible scope" (Mühlbach, 2022).
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Limiting government debt by real conditions
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The previously applicable limits of government debt do not reflect the real conditions of our economy, society, and environment. Therefore, the second part of this article provides starting points for a more sensible limitation of government debt. One of these is the performance or growth potential of the economy. Of course, the question arises as to how "performance" or "growth" is defined. Mathematically, a lower debt ratio can also be achieved by "growing out of debt". When GDP increases, the ratio between government debt and GDP automatically changes, and the debt ratio decreases. However, since the publication of "Limits to Growth" (Meadows, 1972), and especially with the current economic crisis and economic slowdown, the limits of GDP growth are obvious. It would be better in any case not to consider government debt in the future in relation to GDP, but in relation to an alternative understanding of growth or prosperity that respects social and ecological limits.
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Another starting point is the idea of full employment, which in turn is closely related to our societal structures. For example, many women work "only" part-time because (unpaid) care work is still heavily unequally distributed. Classical MMT proponents (Modern Monetary Theory) argue for limiting government debt based on the availability of actual resources, in this case the availability of human resources for work, rather than based on affordability. They argue that only with full utilization of the economy - i.e., full employment - will new government spending will no longer be "absorbed" or constructively used by the economy, and only then it increases inflationary pressure.
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However, the most fundamental limits of government debt are social, ecological, or planetary limits. Olk, Schneider, and Hickel (2023) add to classical MMT: "we suggest integrating insights from degrowth scholarship into MMT, where social and ecological limits to economic activity still constitute a blind spot". This is closely related to the question of what, and not just how much, government debt is taken on and spent for. Debts are not per se "good" or "bad". Contrary to the myths listed above, a differentiated perspective explains that the sensible use of government debt, for example, for more resilient societal and economic structures, can even mitigate inflationary pressure and, above all, is economically more sensible. Early, sufficient, and targeted investments in more resilient structures pay off in the long term and can even save us from avoidably high costs. "Instead of 'deficit reduction' or interest rate hikes, the solution to these inflationary pressures likely involves larger targeted deficit spending alongside improved public-private coordination" (Bernal, 2021, p. 13). This logic also justifies the demand for a corresponding investment agenda (e.g., Isabella Weber, 2023).
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Conclusion
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Translated into some political applicability, this could mean structuring a country's debt issuance in such a way that all necessary investments are made, which do not exceed the economic, social, and ecological limits and at the same time ensure human life on Earth within planetary boundaries. It is clear that limiting government debt alone is not an end in itself for "good" budget management.

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Disclaimer: This article is a translated version of the intervention that was originally published in German language as part of the Economists For Future Debate Series in the online magazine Makronom. Hence, some of the linked references are in German. 

About the authors:

Carolina Ortega Guttack studied Social-Ecological Economics and Policy in Vienna and previously Economics and Political Science in Lüneburg and Paris. She was active in the Plural Economics Network and works at FiscalFuture.
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Carl Mühlbach studied Economics in Heidelberg, Cambridge, and Berlin. In addition to working at the Federal Ministry of Finance, he founded FiscalFuture and leads the cross-party initiative as managing director.
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Tung Doan studied Economics and Public Economics in Mannheim and Berlin. As a founding member, he helped build FiscalFuture. He now works full-time for the initiative and is responsible for finances.

About FiscalFuture: 

FiscalFuture is a non-partisan and non-profit initiative advocating for sustainable fiscal policy. We make fiscal policy accessible by sharing knowledge and inspiring young people to shape the discourse. Our nationwide network is committed to fiscal policy that prioritizes the interests of future generations.

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