Germany to ease government debt limits to boost economy and defence spending

Yahoo

05-03-2025

The two political parties expected to form the next German government have agreed to loosen the country's constitutional restrictions on borrowing, enabling €1 trillion or more in spending on defence and infrastructure.
It's a major change in Germany's debt-averse political culture. Intensifying debate over the debt brake throws into question the economic wisdom that has dominated Europe's biggest economy and one of the world's wealthiest countries.
Germany's recent economic malaise has nonetheless fuelled calls for reform.
Here are key facts about the debt brake and what the changes will mean for Germany and Europe.
The debt brake was passed in 2009, when the global financial crisis led to a sharp increase in government borrowing in Germany and around the world. The debt brake also reflected cultural and political scepticism about debt in general that for years left a deep imprint on German politics.
The debt brake limited new borrowing to 0.35% of gross domestic product - a tight limit when compared to European Union budget rules requiring less than 3%, and the 2024 US federal deficit of 6.4%.
The debt brake appeared to work fine for years - until it didn't. German governments lived within the limits during the good times in the 2010s, often running small surpluses.
But the pandemic, slowing growth and Russia's invasion of Ukraine put the debt brake under severe strain.
The government had to invoke an emergency clause to borrow and spend more on pandemic relief for businesses in 2020.
Then it declared another emergency in 2021, and another one in 2022 after Russia's invasion of Ukraine raised pressure for more defence spending and relief for utility customers.
Yet another emergency exemption was used in 2023.
However, in late 2023 the Federal Constitutional Court ruled the government had gone too far in fudging the debt limit, forcing a frantic rewrite of the 2024 budget.
Then Social Democrat Chancellor Olaf Scholz's government collapsed in November 2024 over a disagreement with a coalition party, the pro-business Free Democrats, over spending and the debt brake.
The reformed debt brake would remove the constitutional ceiling when it comes to defence spending.
That would support efforts to build up Germany's own defences and its ability to further support Ukraine.
Germany is already a leading backer of Ukraine, sending 60 Leopard tanks and 175 Marder infantry fighting vehicles as well as 27 air defence systems, including three of its US-made Patriot missile batteries.
'The extra room for defence spending sends a clear signal to Vladimir Putin and Donald Trump as well as to Germany's European friends that Germany is serious about defending itself and helping Ukraine,' said Holger Schmieding, chief economist at Berenberg bank.
'Germany is finally taking on the leadership role which, given its size and its fiscal space, it should have assumed years ago.'
Leaders of the conservative Union bloc agreed with the centre-left Social Democrats to exempt military spending over 1% of GDP from the debt limit, as well as a €500 billion infrastructure fund for civil and disaster protection, transport infrastructure, hospitals, energy infrastructure, education, scientific research and digitisation.
Economists estimate that the measure, if passed, could enable a trillion euros in new borrowing and spending over a decade.
The agreement came during talks aimed at forming a coalition government between the two parties.
It was a sharp turnaround for Friedrich Merz, who as Union leader is the likely next chancellor after his party came in first in national elections on 23 February.
His party program rejected changes to the debt brake, though he had indicated he might be open to negotiation on that point.
The move 'follows the old political principle: if the facts change, I change my mind,' said Carsten Brzeski, global chief of macro at ING bank.
The agreement reflects both long-term strains on the debt brake, and the sudden recent shift in US security policy under US President Donald Trump, who has demanded that Europe do more for its own security, disrupting the post-World War II transatlantic alliance under which Europe looked to the US as an ultimate security guarantor.
Trump's public disparagement of Ukrainian President Volodymyr Zelenskyy in the Oval Office and the decision to suspend military aid to Ukraine have forced European governments to boost their defence spending to fill the gap left by the US - which is seen as no longer committed to Europe's security.
Germany only met the NATO requirement to spend 2% of GDP on defence through a €100bn special fund exempted from the debt brake in 2022 - but that fund will run out in 2027.
The parties plan to rush the changes through the lame-duck parliament next week.
That's because mainstream parties have a two-thirds majority in the old parliament - but will lose that in the new parliament due to electoral gains by the far-right Alternative for Germany and the far-left The Left party who oppose the changes.
The measure would still need votes in the outgoing parliament from the environmentalist Greens, who weren't part of the coalition talks.
Economists say the looser debt brake could help Germany emerge from five years of economic stagnation by increasing spending on things that promote economic activity over the long term.
Skimping on infrastructure spending has been blamed for trains that don't run on time due to endless track repairs, crumbling bridges, declining educational achievement levels, and lagging adoption of renewable energy infrastructure and digital technology.
The morning after the announcement, economists started tearing up old growth forecasts and raising their outlook.
Morgan Stanley saw the possibility of 0.2% more GDP growth this year and 0.7% more next year.
That would be welcome in an economy that shrank for the past two years.
'Everything you thought you knew about Germany's economic prospects three months ago, or even three weeks ago, should be ripped up,' said Jim Reid, research strategist at Deutsche Bank. 'This is game-changing if it goes through.'
The step is a 'sea change' in German policy, said economist Schmieding.
'The infrastructure fund signals that the new government will seriously tackle key domestic deficiencies,' Schmieding said. 'I look forward to the day in the – probably still somewhat distant – future when German trains may run as fast and punctual as those in France, Switzerland or Austria.'