Germany's New Debt Brake: A Blueprint for Europe?

Many policy reforms are introduced with a significant lag between the time of legislative passage and their actual implementation. This is also the case for a new constitutional rule in Germany, referred to as a debt brake (Schuldenbremse), which requires the federal and state governments to run (almost, cyclically adjusted) balanced budgets from 2016 and 2020 onward, respectively. In this context I analyze within a simple political-economy model, where politicians are less patient than citizens, the costs and benefits of a credibly announced but lagged deficit or debt ceiling. I show that a balanced-budget rule is at best as effective as not having such a rule in terms of implementing the first best. In an important benchmark case, the first best cannot be reached at all. By contrast, a constitutional limit on the future debt level is more effective, even though the first best cannot be always reached when politicians are too impatient.