Never let a good crisis go to waste: Germany’s Zeitenwende moment is now

The soon-to-be German Chancellor, Friedrich Merz, seized the opportunity to propose an increase in defence spending and a constitutional amendment to end the debt break and allow much needed infrastructure spending over the next decade. The increased spending on infrastructure is likely to have a multiplier that is close to 1, and this should boost Germany’s flaccid GDP growth rates over the next decade. In addition, it paves the way for accelerated EU-level decision-making on loosening defence spending rules nationally and establishing EU-level borrowing for defence.

Joining with the centre-left Social Democratic Party (SPD), Mr Merz’s centre-right Christian Democratic Union (CDU) and its Bavarian sister party, the Christian Social Union (CSU), reached a deal that includes three important initiatives:

• the exemption of defence expenditure above 1% of GDP from the constitutional debt brake;
• the creation of a new €500bn fund for infrastructure, to be drawn down over the next ten years, designed to stimulate growth and address a notable weakness in the country’s business environment; and??
• a relaxing of borrowing restrictions on Germany’s 16 states. The states currently cannot take on new debt; the revision would enable them to incur new borrowing of up to 0.35% of GDP on a structural basis.

It is important to note that German government expenditure amounted to nearly 50% of GDP in 2024, and the anticipated €500bn will be spent over a ten-year window, with the largest portion likely to be spent in 2026-28. If spent evenly, it would amount to just over 1% of GDP per year. Anticipated stronger growth and higher debt levels caused German ten-year bond yields to rise by more than 30 basis points to close at 2.79%. Yields are likely to remain at higher levels so long as stronger growth is anticipated. The ten-year yield has continued to rise following the European Central Bank’s 25-basis-point cut to overnight rates, to 2.5%. The steeper yield curve should also revive private-sector credit from just over 85% to closer to 90%, unlocking another engine of growth.?

Germany’s Zeitenwende moment is arguably the biggest government initiative since reunification, and it could well mark the beginning of an ascending Europe, with Germany taking a leadership role commensurate with its position as the fourth-largest economy in the world.

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