Germany’s Fiscal Transformation

Whatever It Takes

Echoing Draghi’s famous speech in July 2012 at the height of the eurozone sovereign debt crisis, Merz recently stated that “in view of the threats to our freedom and peace on our continent, ‘whatever it takes’ must now also apply to our defense.” While the macroeconomic environment is different today, Draghi’s speech marked a pivotal turning point for the eurozone and led to a surge in confidence, restoring stability in the currency bloc and supporting the euro (EUR). Similarly, Merz’s speech heralds a potentially unparalleled period of fiscal spending and reforms.

Merz’s reforms are significant in terms of both their magnitude and timing. On magnitude, the relaxation of Germany’s debt brake, a significant increase in defense spending, and the creation of a €500 billion infrastructure fund are estimated to result in spending of approximately 20% of GDP over the next decade. On timing, Merz’s unprecedented passage of these fiscal measures in the four-week interim period between the federal election and the introduction of the new Bundestag at the end of March, where he would likely have failed to garner enough support to pass debt reforms, highlight the sense of urgency for change.

While Germany has faced long-term structural problems, its weakness relative to the rest of the eurozone has been more pronounced in the post-pandemic era, with real GDP growth averaging little more than 0% (see Exhibit 2). Germany continues to be plagued by a shrinking manufacturing sector hurt by rising labor costs and competition from China; costly energy prices due to numerous fees/taxes, a slow transition to renewables, and a grid system in need of maintenance; and an aging demographic. Given the weak starting point of the economy, Germany has ample room to reinvigorate growth, with estimates ranging from a 0.5% to 1.0% boost each year from fiscal spending plans.

Galvanizing Europe

Others in Europe have taken note of Germany’s historic shift and shown a desire to become less dependent on the US. In March 2025, European Commission President Ursula von der Leyen released the ReArm Europe Plan. The strategic defense initiative provides member states with €150 billion in loans for joint defense projects and €650 billion in increased fiscal space. Recent geopolitical events also have renewed other European countries’ focus on meeting—or even potentially exceeding—the minimum 2% NATO defense spending target. Sweden, for example, announced it would increase defense spending to 3.5% of GDP by 2030. Additionally, leaders across Europe have discussed greater cooperation on defense, with French President Emmanuel Macron emphasizing the existential threat posed by Russia and highlighting France’s nuclear arsenal as a source of protection for Europe more broadly.

However, there are risks that markets may be overly optimistic on the latest developments. While Merz has created the fiscal space, the actual implementation of his policies may fall short. Other European countries may not follow Germany’s model due to fiscal restraints, including higher starting debt levels and higher funding costs, or political constraints that prevent the passage of new legislation. Furthermore, tariffs from the US are a near-term headwind and could be particularly disruptive to the eurozone, which is a large producer and exporter of autos and pharmaceuticals and has high value-added taxes.

Longer-Term Support Over Quick Boost

Financial markets have been quick to react to the fiscal reforms, with EUR appreciating against the US dollar (USD) and German 10-year bund yields initially rising on increased growth prospects and issuance. Further defense and infrastructure spending from other European countries as well as the knock-on effects to private consumption and investment could drive further appreciation. While additional near-term upside may be limited, Germany’s fiscal boost is expected support financial assets over the medium to long term.