Germany finally unveiled a plan that could address years of economic decline and the war in Ukraine as the country announced plans to change its constitution and abandon its long-standing commitment to fiscal prudence.
The CDU/CSU and SPD parties agreed to a mammoth spending package on Tuesday, the headline of which was a €500 billion ($535 billion) fund over 10 years dedicated to upgrading German infrastructure, including across transport, energy, and digitization.
The coalition also sealed a groundbreaking agreement to exempt defense spending above 1% of GDP from its strict debt brake, opening a path for the country to join the rest of Europe in upping its defenses.
Speaking following the agreement, Germany’s chancellor-in-waiting, Friedrich Merz, emphasized the new reality Germany finds itself in as relations between the U.S. and Europe fracture.
“The political developments in Europe and the world are evolving faster than we anticipated just a week ago,” said Merz. “Germany and Europe must now undertake extraordinary efforts to ensure our defense capabilities.”
Analysts expect that taken together, the spending packages could eventually surpass €1 trillion ($1.3 trillion), representing about a quarter the size of Germany’s economy.
“This is huge,” said Kathleen Brooks, research director at XTB. “For years, economists have said that Germany needed to change its spending rules to get out of the economic hole. It’s taken a Conservative Chancellor-in-waiting to pull the trigger.”
Germany’s debt brake was introduced in 2009, restricting the annual budget deficit to 0.35% of GDP. The brake proved popular with German citizens, particularly as parts of southern Europe fell into major debt crises in the 2010s.
However, the debt brake has turned burdensome as Germany’s economy endures newfound economic struggles. Russia’s invasion of Ukraine put pressure on energy prices in the country. Meanwhile, Germany’s export-heavy economy has been racked by flagging demand in China. Import tariffs on goods to the U.S. are expected to cause further pain for producers.
Germany fights back
Germany’s myriad struggles have resulted in two consecutive years of economic growth, with economists projecting a further decline in 2025. In the process, there have been growing calls to scrap the debt brake and allow Germany to spend its way out of decline.
In Morgan Stanley’s new upside scenario following the spending announcement, Germany’s economy could grow by 0.6% this year and by 1.6% in 2026.
The bank remains bullish on German defense stocks in the wake of the announcement, with the country’s biggest contractor, Rheinmetall, doubling in valuation since the start of the year.
XTB’s Brooks says Germany’s new measures would inevitably lead to rising debt, but that that was a problem for another day.
“For now, the euro is the best performing currency in the G10 FX space this week, the Dax is continuing to dominate the equity market, and rising bond yields suggest a transformed economic outlook. Germany is back.”
Germany’s defense pledge, which could see spending as a percentage of GDP exceed 3%, is a massive statement of intent from Europe’s largest economy after years of perceived underinvestment. The country has repeatedly fallen short of the NATO pledge to spend 2% of GDP on defense since the guideline was introduced in 2014.
On Tuesday, the EU announced a spending plan that could unlock €800 billion ($840 billion) for rearmament within the next four years.
