A New Fiscal Path: Germany Opens the Door to Strategic Spending

On the 18th of March 2025, the German Parliament passed a package of constitutional reforms, unleashing hundreds of billions of euros earmarked for defense, infrastructure, and projects.

For decades, Germany has been considered the epitome of fiscal discipline. From the early days of the European Monetary Union, the Bundesbank has opted for tight budgetary controls and low inflation policies, resisting fiscal expansion. With this historic shift, the Bundestag is easing the restrictions imposed by the “debt brake” (Schuldenbremse), which limited fiscal room for maneuver since its introduction in the German Constitution in 2009.

This U-turn in fiscal policy is going to allow the EU's largest economy to increase its structural deficit to 1.4% of GDP, compared to the previous limit of 0.35%, provided the debt-to-GDP ratio stays below the EU rules level of 60%.

Ultimately, the new reform will add an additional €220 billion by 2030, primarily targeted towards long-term investments in infrastructure, digitalization, and climate transition projects. It will also allow defense spending above 1% of GDP to be excluded from borrowing limits.

“Our reform proposal for the debt brake preserves sound public finances whilst at the same time facilitating urgently needed investment”, Bundesbank President Joachim Nagel said.

Why Now?

Germany’s chancellor-in-waiting Friederich Merz has heavily supported the package, which he deems of crucial importance in the fight against the breakdown of transatlantic relations, growing international instability and the increased need for defense.

The German economy, after a decade of export-driven growth, is now facing stagnation. The country is dealing with aging infrastructure, geopolitical uncertainty, and energy insecurity. All these factors, together with the Covid pandemic, almost pushed the country into a recession, with its long-term potential growth rate falling below 1%.

Germany’s lack of fiscal flexibility due to strict regulations has certainly exacerbated the effects. However, EU member states have come under pressure to model their economies to respond effectively to today’s unstable geopolitical landscape. In fact, Russia’s invasion of Ukraine has forced the Union’s members to increase their defense spending, while at the same time investing trillions of euros towards climate goals.

While maintaining a degree of fiscal authority, the Bundesbank’s reform acknowledges the need for increased public investment.

Market Reactions and Economic Impact

The announcement was well received by the market. German government bond yields soared, with the 10-year bond hitting a multi-month high. Overall, investors have welcomed the news, as March economic sentiment skyrocketed to 51.6 points, compared to the 26-point level of February, says the ZEW economic research institute.

Moreover, AXA Group Chief Economist Gilles Moec calculates that Germany’s fiscal shift could ultimately be self-financing with returns from stronger economic growth offsetting the higher cost of borrowing demanded by the bond market.

As the EU’s largest economy, which has been a fiscal role model, Germany’s shift will put under revision of the EU Commission the Stability and Growth Pact (SGP).

Member states are, in fact, advocating for a more flexible framework, while maintaining fiscal sustainability.

Political Hurdles and Debate

Passing the reform required a two-thirds majority in both the Bundestag and Bundesrat (Federal Council).

After weeks of tough negotiations, a compromise between the Christian Democratic Union (CDU), its Bavarian sister party the Christian Social Union (CSU), the center-left Social Democrats (SPD), and the Greens was reached. While the SPD and the Greens had long advocated for relaxing the debt brake, the CDU had resisted any permanent changes to Germany’s fiscal framework. However, in preparation for the post-Scholz political landscape, the formation of a coalition between SPD and CDU created the necessary political space for a deal.

In the coalition negotiation, the SPD managed to secure key concessions on long-term investment financing, forcing the CDU to accept a partial redefinition of the Schuldenbremse. On the other hand, the CDU negotiated strict conditionality on deficit limits and sunset clauses on defense-related exemptions. Although not being a part of the merging coalition, the FDP (Free Democratic Party) has expressed its firm opposition to the reform, warning that the amendment would undermine Germany’s fiscal credibility.

Despite the FDP’s resistance, the coalition ultimately secured the supermajority required to amend the Grundgesetz.While civil groups and economists remain divided, the debate reflected the deep ideological divides within the German Parliament. The outcome not only reshapes Germany’s future fiscal policy but also signals a broader shift in the EU’s fiscal stance.

A Ripple Effect Across Europe?

Considering Germany’s international relevance, the size of its economy, and industrial complex, it is very plausible that the Bundesbank’s policy shift will have repercussions also outside the country.

The Germans’ orientation towards pragmatism and enhanced but calculated risk is likely going to steer the EU towards a more flexible approach in the Stability and Growth Pact, in order to foster investment while properly regulating debt. This new stance could be greeted favorably by a group of EU nations which, in recent history, has always been critical of the rigid rules imposed by the Union.

The common stance may, ultimately, tilt the balance in favor of a reform of the SGP.

Lastly, the Bundesbank’s new approach might lead to a revamping of the NextGenerationEU fund, increasing support towards common climate neutrality and defense goals.

“If Germany moves, the rest of Europe can follow.” stated Merz, highlighting the huge influence of Germany in the economy and decision-making process of the European Union.

Looking Ahead

The policy reform indicates a shift in how countries conceive the economy and its relationship with the state and future generations.

Although recently approved, its symbolic and political importance is sparking a broader debate on how best align strategic investment with fiscal responsibility and stability.

The EU seems to be entering a new period of economic open-mindedness, where goals and challenges are faced with a long-term approach, considering sustainability and the well-being of future generations.

Ig: @riccardoopinnaa and @sas_berre