Germany’s Christian Democrats (CDU/CSU) and Social Democrats (SPD) have announced that they will ease Germany's restrictive debt policy: a special fund is to enable investment in infrastructure and the debt brake will be relaxed for defense spending. In our latest SAFE Policy Letter No. 105, we argue for a more flexible debt policy that also benefits the market by providing more secure assets. This is because German government bonds play a crucial role as a stabilizing pillar of Europe’s financial architecture. However, to date these securities are artificially scarce due to the limited leeway in debt policy. A more flexible solution consolidates Germany's role as an anchor of stability in the eurozone and thus strengthens European sovereignty.
Safe assets are not a burden but a necessary good for stable and functioning financial markets. They serve as reliable collateral for financial transactions and support the repo market – a key component for liquidity and risk management. Especially in times of crisis, such as during the Euro crisis or the COVID-19 pandemic, these assets have proven indispensable. In the eurozone, only German government bonds can meet the necessary criteria for safe assets (low default risk, high liquidity, low volatility).
Compared to other European countries such as Italy, France or the Netherlands, Germany has permanently lower interest rates (safe asset premium), which strengthen in times of crisis (see Figure 1). The argument that yield spreads are explained by Germany’s low debt ratio is refuted by the example of the Netherlands, which has a lower debt ratio yet exhibits a positive yield spread compared to Germany.
Figure 1: Yield spread compared to ten-year German government bonds
Source: Federal Reserve Bank of St. Louis (FRED), authors' calculations
The repo market is one of the most important components of the financial markets and is closely linked to the function of safe assets. Repurchase agreements, or repos for short, are short-term financing transactions in which a security, usually a safe asset such as a government bond, is deposited as collateral. The repo market ensures liquidity and stability in the financial system as it facilitates access to short-term financing while minimizing the risks for the parties involved. A lack of safe assets can therefore unbalance the financial system in times of crisis.
A problem with global consequences
The shortage of German government bonds means that European financial institutions are increasingly turning to US government bonds. Over the past seven years, the share of US bonds in the European repo market has risen from 5% to over 15%, surpassing Germany for the first time in 2024 (see Figure 2).
Figure 2: Collateral in the European Repo Market by Country
Source: International Capital Market Association European Repo Market Survey No. 35-47, Table 2.8
The assumption that Germany's low sovereign debt is a guarantee of European stability is therefore too easily made. As long as the Eurozone lacks sufficient safe assets, Germany’s restrictive fiscal policy leads to the import of foreign government bonds—and thus the import of foreign sovereign debt risks. Adding to that: The market is willing to pay a premium for safe assets, but right now, it is the American taxpayers who profit, not the German ones.
The solution: A flexible debt policy
The planned reform by CDU and SPD loosens Germany's debt policy. This is an opportunity to create safe assets and not artificially reduce them.
It would:
- Strengthen Germany's position as an anchor of stability in the eurozone and thus provide new stability to the European financial market,
- Reduce dependence on US government bonds,
- Allow German taxpayers to benefit from the safe-asset premium.
Florian Heider is Scientific Director of SAFE.
Jonas Schlegel is Financial Economist at the SAFE Policy Center.
Blog entries represent the authors’ personal opinion and do not necessarily reflect the views of the Leibniz Institute for Financial Research SAFE or its staff.
