Have Germany’s Fiscal Policymakers Made Good Use of the Relief Provided by Low Interest Rates?

Imagine a married couple without children who are faced with the following situation. They are highly indebted from living beyond their means for many years; their home is freshly painted but run down on the inside, and the repairs needed are expensive; to boot, the couple has no savings for retirement. But then, unexpectedly, they win 50,000 euros from playing the lottery. This is not enough to eliminate their financial problems, but still a tidy sum.

What advice would we give them? Clearly, we would recommend paying off some of their debt rather than spend their winnings on new consumer goods.

The German state is in a situation similar to the married couple: debt is high; the euro crisis has created untold burdens; the population is shrinking; yet Germany has been lucky. How so? While, to my knowledge, none of Germany’s financial ministers has won the lottery over the last decade, capital markets have brought massive relief thanks to falling interest rates. According to the calculations of the Federal Ministry of Finance, low interest rates saved the German government around 41 billion euros between 2010 to 2014 alone. And this is just part of a longer trend. In 2000, the share of interest expenditures in the federal budget was just shy of 16%. By 2005, it was 14%. It was under 11% in 2010 and under 10% in 2012.

During the same period, however, federal government debts have risen massively – by some 40%. If interest expenditures had also risen by 40%, the federal budget would have paid 55 billion euros. But the actual figure for interest expenditures is only 30 billion. What should the state do with the windfall?

A national economy is not the same as a private household, of course, but eliminating state debt is important nonetheless. As with lottery winnings, savings from low-interest rates represent a one-time relief. Theoretically, you can win the lottery a second time, but you shouldn’t count on it. This is also true for low interest rates. Eventually they will rise. Have politicians done the right thing and used the relief in order to eliminate debt? Judging by the total federal budget as a percentage of GDP, we’d have to say no. Federal government expenditures amounted to just short of 12% of the GDP in 2000, and this has changed little since, despite sinking interest expenditures. Instead of eliminating debt, the German government has been spending money on other things – social services first and foremost. Outlays for social insurance have risen from around 30% of the federal budget in 2000 to around 37% today. The increased expenditures roughly correspond to the money saved due to low interest rates. And although the net credit level has sunken, this is attributable to higher tax revenues.

What’s the upshot? German financial policy of the last decade has failed to take advantage of low interest rates to decrease debt. And now an aging population will keep up pressure to increase social spending. Interest expenditures will go from being a relief to a burden. And Germany’s public finances are not prepared. Politicians demand that citizens plan for their future. They should follow their own advice and set a good example.