Germany finally shakes off its fiscal straitjacket to cope with tectonic shifts

In the aftermath, early federal elections were held in February 2025, resulting in a "grand coalition" between the Christian Democratic Union (CDU) and the SPD, led by Chancellor-elect Friedrich Merz. The new coalition, unlike Scholz’s, was successful in introducing a substantial borrowing plan, amounting to over €1 trillion, to revitalise the economy. This includes a €500 billion fund dedicated to infrastructure investments over 12 years, with €100 billion earmarked for climate-related projects. Additionally, defence spending is set to increase with the expansion of the €100 billion Special Defense Fund, initiated post-Russian invasion of Ukraine.

The end of inflexible austerity

The Bundestag, the lower house of the parliament, initially approved the amendment with a two-thirds majority, securing 513 votes in favour and 207 against. On March 21st, the legislation was passed in the Bundesrat, the federal council representing Germany's 16 states, thereby enacting it into law. This decisive vote reflects a broad consensus among major political parties on the necessity of the reform.

Since 2009, Germany’s “Schuldenbremse”, or debt brake, has legally constrained federal deficits to 0.35% of GDP. This was seen as a moral compass for fiscal prudence, particularly after the Eurozone crisis. But it also became an ideological straitjacket, limiting vital public investments in infrastructure, digitalisation, climate adaptation, and even military readiness.

The recent vote to provide carveouts from the debt brake for a public infrastructure fund and for defence expenditures beyond 1% of GDP marks a watershed. It redefines the terms of permissible state intervention in the economy and signals a European disavowal of the austerity-first model.

The country had temporarily suspended the debt brake during the COVID-19 pandemic and the consequent energy crisis. The 2025 amendment, in contrast, creates permanent structural exemptions, signalling a paradigm shift in fiscal philosophy.

Borrowing for the future, not the past

This shift also reflects a broader, global rethinking of the post-2008 economic order. The U.S. has already embraced trillion-dollar industrial strategies through the Inflation Reduction Act and CHIPS Act. The European Union is reshaping its Stability and Growth Pact to allow for “green golden rules.” Now, Germany’s volte-face gives political and institutional legitimacy to a new economic consensus: strategic borrowing for transformative investment is not just acceptable; it is necessary.

In 2023, the Federal Constitutional Court invalidated the government’s practice of reallocating unused emergency COVID funds for long-term climate investment. This ruling forced a freeze on planned spending on climate, energy transition, and defence, leading to widespread uncertainty in both domestic and foreign investment.

The country, long hailed as Europe's economic engine, has been undergoing one of its most critical economic transitions since reunification. Years of underinvestment in infrastructure and digital transformation have left Germany lagging. Rising interest rates and construction costs have triggered a slowdown in the housing and real estate sector.

Further, an ageing workforce and declining birth rates reduce labour productivity and increase dependency ratios. As a result, Germany was one of the few major EU economies to contract in 2023. The IMF forecasted only modest growth for 2024, and German policymakers have faced pressure to abandon old economic orthodoxies to avert stagnation.

Balancing books, tilting power

The implications of this decision go beyond economics, reflecting a dramatic shift in Germany’s post-WWII strategic culture. It echoes the lessons of Ukraine: peace cannot be assumed, and dependence on external security guarantees, be it NATO or the U.S., is no longer tenable. A militarily assertive Germany, rearmed with public spending, can alter the balance of power within Europe and NATO. For Washington, it offers a much-needed “burden-sharing” partner. For Russia and China, it is a clear signal that Europe is mobilising for long-term strategic competition.

For India, Germany’s fiscal pivot carries both geopolitical and economic implications. At a moment when India is seeking closer strategic ties with Europe through trade, climate cooperation, and Indo-Pacific engagement, this policy overhaul presents opportunities. The enhanced defence budget may catalyse greater technological and defence collaboration with India, especially under frameworks like the India-EU Strategic Partnership. In fact, shares of previously underperforming defence and shipbuilding companies surged by as much as 20% on Wednesday following the parliamentary vote.

Further, the earmarking of €100 billion for climate and green infrastructure opens possibilities for green finance cooperation, R&D partnerships, or joint manufacturing in renewable technologies.

There is, however, a flip side. Germany’s increased borrowing may contribute to rising global bond yields, potentially making capital more expensive for emerging economies like India.

Hence, while Germany’s policy pivot can be applauded for its courage and clarity, success will depend on the efficiency of targeted spending, coordination with EU fiscal and monetary policy and transparency. If managed well, Germany could not only revive its economic engine but also redefine the future of European economic governance.

(Vanshika Saraf is Research Analyst, Indo-Pacific Studies Programme, The Takshashila Institution.)

Views are personal and do not represent the stand of this publication.