Germany’s ‘unprecedented’ plan could lift growth

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Germany’s ‘unprecedented’ plan could lift growth

Published: 18 Mar. 2025, 00:03

Audio report: written by reporters, read by AI

Ha Hyun-ock

The author is an editorial writer at the JoongAng Ilbo.

Germany has changed. After 16 years of strict fiscal discipline, the country is shifting gears toward large-scale economic stimulus. On March 14, Germany’s coalition parties — the Christian Democratic Union (CDU), the Christian Social Union, the Social Democratic Party and the Greens — announced an agreement to amend the constitution to establish special budgets for infrastructure and defense. With the required two-thirds majority secured, the amendment is expected to pass in the parliament's plenary session on March 18.

The driving force behind this policy shift is CDU leader Friedrich Merz, widely favored to become Germany’s next chancellor. On March 4, he unveiled an unprecedented infrastructure and defense spending plan aimed at economic recovery and national security. The key proposal is to exempt these expenditures from the country’s strict “debt brake” policy by amending the constitution.

Germany introduced the debt brake in 2009 following the global financial crisis, limiting fiscal deficits to 0.35 percent of the GDP. If the accumulated deficit reaches 1.5 percent of the GDP, a balanced budget must be implemented. While designed to ensure fiscal prudence, the policy has often been criticized for constraining public investment and hindering economic growth.

Under the special budget agreement, three major changes will be implemented. First, the cap on defense spending will be removed, allowing any expenditure exceeding 1 percent of GDP to be excluded from the brake — effectively enabling unlimited borrowing through government bonds. Second, a 500 billion euro ($543.9 billion) infrastructure investment fund — some 12 percent of Germany’s GDP — will be created over the next decade to address chronic underinvestment. Third, fiscal rules for state governments will be eased, allowing them to take on additional debt of up to 0.35 percent of GDP annually, similar to the federal government.

Friedrich Merz,center, leader of the Christian Democratic Union of Germany (CDU), a candidate for German chancellor, delivers an address at the headquarters of the CDU in Berlin, on Feb. 23. [YONHAP]

If the agreement is fully implemented, Germany will inject 1 trillion euros into defense and infrastructure over the next decade. According to iM Securities, Germany’s nominal GDP in 2024 is projected to be around 4.3 trillion euros, with a federal budget of 465.7 billion euros. Given these figures, the special budget plan is being hailed as an unprecedented stimulus package by market analysts, with Deutsche Bank calling it “the most historic paradigm shift since World War II” and Bank of America touting it as a “complete game changer.”

Germany’s economic decline: From powerhouse to ‘sick man of Europe’

Germany’s longstanding obsession with fiscal balance is well known, rooted in its traumatic experience with hyperinflation. During and after World War I, the government ramped up bond issuance and printed money recklessly to fund war expenses and reparations, leading to extreme inflation. By 1923, the value of one U.S. dollar had soared to 4.2 trillion marks. The economic devastation contributed to the rise of the Nazi regime, making Germany particularly sensitive to inflation.

This historical trauma led Germany to enforce even stricter fiscal rules than the European Union requires. The EU mandates member states to keep fiscal deficits below 3 percent of their GDP and national debt below 60 percent of their GDP. Germany’s deficit ratio stands at 2.6 percent, and its national debt-to-GDP ratio was 63 percent last year — relatively healthy compared to other EU nations. However, this rigid fiscal discipline has often prevented necessary spending during economic downturns.

Now, Germany is setting aside its historical constraints to embrace deficit spending, driven by economic stagnation. The country experienced negative growth in 2023 of 0.3 percent, and again in 2024 at 0.2 percent, marking the first back-to-back contractions in 21 years. This year’s growth forecast is flat at 0 percent. Once Europe’s economic engine, Germany has now earned the unwanted title of the “Sick Man of Europe.”

Several factors have contributed to this downturn. As a manufacturing powerhouse, Germany has been hit hard by China’s economic slowdown, its key export market. The 2022 Russia-Ukraine war led to soaring energy costs, driving up electricity prices and dampening both household consumption and business productivity. Meanwhile, German automakers have struggled to keep pace with the global shift to electric vehicles, while low-cost Chinese products have intensified competitive pressures. Additionally, trade tensions with the United States, including tariff threats, pose further risks to the German economy.

Germany’s dual economic strategy: Fiscal and monetary policy in sync

With Germany facing mounting economic challenges, the urgency for stimulus has grown. U.S. President Donald Trump’s “America First” policies also served as a wake-up call, prompting Berlin to reconsider its approach. Ultimately, the fiscally conservative nation has embarked on a historic shift toward expansionary spending. This drastic measure reflects its determination to regain industrial competitiveness through aggressive investment.

Some analysts believe Germany’s fiscal expansion marks a structural turning point for the European economy. According to a recent report by Samsung Securities, “Germany’s shift in fiscal policy signals the end of the strict fiscal discipline era that began in 2009.” The report notes that while Germany has maintained government debt at 60–70 percent of the GDP since introducing the debt brake, it has done so at the expense of economic growth and public investment.

EU flags flutter in front of European Central Bank headquarters in Frankfurt, Germany on July 18, 2024. [REUTERS/YONHAP]

This shift means Europe will now operate with both monetary and fiscal policy as twin engines of economic management. “Since the global financial crisis, the eurozone has relied almost exclusively on the European Central Bank [ECB] for economic stimulus,” said Samsung Securities researcher Heo Jin-wook. “Germany’s fiscal shift will provide a second engine, making the eurozone’s economic management more effective and stable. The country’s fixation on fiscal balance has long been a structural Achilles’ heel preventing Europe from catching up with the United States.”

Germany’s fiscal expansion to boost Eurozone growth

With Germany shedding its fiscal restraints, expectations for economic recovery are rising. NH Investment & Securities predicts that infrastructure investment funds and increased state government borrowing will create significant demand, playing a crucial role in reviving the German economy. Current estimates suggest that government spending will increase by 200 billion euros annually.

The Macroeconomic Policy Institute forecasts that if the stimulus package is implemented swiftly, growth will accelerate in the second half of this year. “Barring unforeseen shocks, Germany could achieve 2 percent growth in the coming years,” the institute projected.

Growth forecasts are already being revised upward. Goldman Sachs raised its 2024 GDP forecast from 0 percent to 0.2 percent and its 2026 forecast from 1.0 percent to 1.5 percent. Samsung Securities estimates that Germany’s fiscal expansion could boost its annual growth rate by 0.3 to 0.7 percentage points in the coming years. Given that Germany accounts for 30 percent of the eurozone’s GDP, its economic resurgence could improve overall eurozone growth. The International Financial Center estimates that Berlin's fiscal expansion could lift the eurozone’s GDP by 0.4 percentage points.

Germany’s rising interest rates could affect global markets

However, Germany’s massive spending spree comes with risks. The country’s debt-to-GDP ratio, which stood at 63 percent last year, is expected to rise. The International Financial Center projects that if Germany increases spending by 1.5 percent of GDP annually, its debt-to-GDP ratio could reach 70 percent by 2029. Economist Friedrich Heinemann of the ZEW research center warns that this figure could exceed 100 percent by 2034.

Germany’s fiscal expansion will also impact global financial markets. To finance its spending, Germany will issue more government bonds, which could drive bond prices down and push yields higher. On March 5, the day after the stimulus plan was announced, Germany’s 10-year bond yield surged 0.31 percentage points — its largest single-day increase in 28 years. After the constitutional amendment negotiations were finalized on March 14, the yield climbed further from 2.88 percent to 2.93 percent. Goldman Sachs predicts that bond yields could rise by another percentage point.

Since German bonds serve as a benchmark for eurozone debt, their yields influence interest rates not only in Europe but also in the United States and Japan. “Germany sets the standard for eurozone bond markets,” said Daishin Securities researcher Gong Dong-rak. “As German yields rise, interest rates in other countries will likely follow.”

Concerns about inflation are also growing. Austrian central bank governor Robert Holzmann warned that rising tariffs, Europe's rearmament and Germany’s relaxed debt rules could reignite inflation, possibly prompting the ECB to raise interest rates again.

Translated using generative AI and edited by Korea JoongAng Daily staff.