Yesterday evening, an agreement was announced between the CSU/CDU, the winner of the last elections, and the SPD, its most likely partner in forming the next coalition and government, on a radical shift in Germany’s fiscal policy stance.

The plan should be adopted in the coming days or weeks, before 25 March at the latest, by the exiting Bundestag, where a two-third majority is likely to exist for validating those constitutional changes – this may no longer be the case in the new Bundestag resulting from February’s elections.

In essence, the announcements are a huge loosening in Germany’s fiscal policy, where a significant increase in public spendings and debt will finance unprecedented investments in defence and infrastructures:

• A EUR 500bn dedicated fund for infrastructure investments over the next decade will be created. The amount represents 11.6% of Germany’s annual GDP, thus implying about 1% of fiscal support to economic activity per year for the next ten years. This will also help improving German economy’s competitiveness for the future.
• The constitutional debt brake will be amended to exclude defence spendings above 1% of GDP from the public deficit limit. It paves the way to open-ended increases in Germany’s defence spendings, without the constraint of the public deficit limit. Germany’s future Chancellor Friedrich Merz has also pledged to do “whatever it takes” when it comes to defence spendings.
• Additionally, federal states will be allowed to run public deficit (capped at 0.35% of GDP) and will no longer have to strictly balance their budget.

This is a major development that will reshape economic policies in Europe’s largest economy for the years to come. With a low public debt/GDP ratio of 63%, Germany has ample room to increase its public spendings. The infrastructure plan will have a direct positive impact on domestic activity, and the increase in defence spendings will also benefit the economy and especially all German industrial sectors geared to the defence industry.

In parallel of Germany’s announcements, the European Union also unveiled a plan for increased public spendings ahead of tomorrow’s European Council. The plan puts Germany’s effort in a broader European context of more fiscal space for member countries, with some of the effort made at the EU level with joint borrowing.

The main parts of the plan presented by European Commission Ursula von der Leyen yesterday are:

• A ReArm Europe plan, that will allow Member States to increase their defence spendings without triggering the Excessive Deficit Procedure of the existing fiscal framework.
• A EU loan facility of EUR 150bn to support Member States in financing their defence investment spendings, which would be a joint European financing for part of the required increase that European countries will have to face.
• Reviewing the EU budget to direct more funds towards defence-related investments.
• Facilitating and mobilising private capital financing for future European investments needs

With Germany abandoning its long-held doctrine of budgetary orthodoxy, it allows more pro-active fiscal policies to be implemented across all European economies. It also paves the way for joint European borrowings for the necessary investments that will have to be made in the coming years, not only on defence spendings but also on technological and infrastructure investments for raising European competitiveness (cf. Draghi report).

• It is therefore not only about Germany abruptly shifting its stance toward fiscal policy, but also a broader change in Europe’s attitude toward public spendings and deficits, where joint European borrowing and more budget flexibility for European countries will help providing the necessary investments for defence and competitivity, at the expense of rising public debt across all Europe.

It may be a coincidence of the calendar, today also saw the announcement by China of a long-awaited fiscal stimulus program. As US tariffs on Chinese goods are being raised again, China’s Premier Li Qiang unveiled the government’s economic targets for this year:

• A GDP growth of “around 5%” will be targeted again this year, a level that is above the recent growth rate of the world’s second largest economy.
• To reach this target, the budget deficit will be raised by 1%, from 3% last year to 4% in 2025. This which will amount to a USD 180bn equivalent increase in public spendings finance by the issuance of ultra-long term special government bonds.
• Measures to support state-owned commercial banks and raise their capital (USD 70bn equivalent) will also be financed by additional government borrowing.

This morning’s announcements are less of a surprise than the latest European developments as they were hoped since last Autumn. However, they still are significant as they materialise the expected support of Chinese authorities to an economy that has recently stabilised after a long slowdown but continues to record lacklustre domestic growth and will face additional headwinds from the increase in US tariffs.