Germany's economy shrank, and it's facing a spending crisis

FRANKFURT, Germany -- German Chancellor Olaf Scholz on Friday promised quick action to fix a budget crisis after a court decision blew a large hole in the almost-finished plan for next year and threatened to disrupt spending on efforts to fight climate change and cushion the impact of high energy prices caused by Russia's invasion of Ukraine.

“Some are asking whether the financial support from the federal government, which caps high energy prices, can keep flowing or must be paid back," he said in a video posted to X, formerly known as Twitter. "Those are “justifiable questions.”

Scholz said, however, that the government is “firm in our intention to modernize our country, so that in future, we have strong industry, good jobs and good pay when our economy is climate neutral.”

Scholz’s reassurances come as the budget crisis threatens to exacerbate problems in the world’s worst-performing major developed economy. Figures released Friday laid those issues bare.

Europe's largest economy contracted 0.1% in the July-to-September quarter as inflation eroded people's willingness to spend, Germany's statistics office said.

Germany is the only major economy expected to shrink this year, according to the International Monetary Fund, which foresees a decline of 0.5%.

Meanwhile, the closely watched Ifo institute survey of business optimism showed a tiny uptick to 87.3 for November from 86.9 in October but remained well below its July level, meaning business confidence is still in the dumps.

The country’s budget crisis raises the possibility of spending cuts next year, which economists say would worsen the challenges facing the stagnating German economy. It's struggling to adapt to long-term challenges such as a shortage of skilled workers and the loss of cheap natural gas from Russia after the invasion of Ukraine.

A court ruled last week that previous spending violated constitutional limits on deficits, forcing Scholz’s government to put off a final vote on next year’s spending plan and search for ways to fill a 60 billion euro ($65 billion) budget hole over this year and next.

The country's Constitutional Court ruled that the government could not repurpose unused funding meant to ease the impact of COVID-19 into projects to fight climate change and offer relief to consumers and businesses hit with high energy costs.

The court said the move violated rules in the constitution that limit new borrowing to 0.35% of annual economic output. The government can go beyond that if there's an emergency it didn't create, such as the pandemic.

The ruling has tied Scholz's quarrelsome, three-party coalition in knots as the cabinet tries to comply, raising uncertainty about which government programs will be cut.

Scholz said the court ruling, while banning spending in this case, upheld that exceptions to the debt rules were allowed in emergencies. He said the government would keep pursuing its goals of transitioning the economy away from fossil fuels and protecting consumers from higher energy prices.

Analysts say about 15 billion euros had already been spent in this year's budget, some of it on relief for utility bills.

Finance Minister Christian Lindner has proposed invoking an emergency again this year to bring spending in line. But the bigger problem is the 35 billion to 40 billion euros that the government can no longer borrow and spend next year.

That could mean cuts in the climate and transformation fund, which supports projects that reduce emissions from fossil fuels. Those include renovating buildings to be more energy efficient; subsidies for renewable electricity, electric cars and railway infrastructure; and efforts to introduce emissions-free hydrogen as an energy source.

It also includes support for energy-intensive companies hit by high energy prices and for computer chip production.

“There doesn’t seem to be a strong growth driver in sight,” said Carsten Brzeski, chief eurozone economist at ING bank.

He termed the uptick in the Ifo survey of business managers as “a bottoming out” rather than a rebound.

“This is why we expect the current state of stagnation and shallow recession to continue," Brzeski said. "In fact, the risk that 2024 will be another year of recession has clearly increased."