Germany’s incoming “grand coalition” of Christian Democrats and Social Democrats is about to commit the biggest economic policy error since unification – the attempt to pursue budget consolidation at the expense of all other economic policy goals. In doing so, it risks turning a five-year-long stagnation into a full-scale depression.

The CDU and SPD have discovered a financing gap of between €35bn and €70bn ($41bn and $83bn), or between 1.6 and 3.2 per cent of gross domestic product, which they plan to consolidate at once in 2006. Since the SPD will not accept large spending cuts, much of the consolidation effort will come in the form of tax increases. The most visible will be a rise in value-added tax by between 2 and 4 percentage points. Given the weakness in domestic consumption, such a strong increase in VAT could seriously hurt the economy.