After the post-COVID recovery, Germany contracted in 2023 and 2024 (-0.9% and -0.5%) but managed to change the trend in 2025 (+0.2%) and all signs point to fiscal expansion gaining traction this year to reach 1.2%, although the reform momentum has disappointed and much of the fiscal "bazooka" will be used to plug holes.
Text: Matin Wolburg (Generali Investments) •
After the early elections held at the beginning of 2025, German conservative Chancellor Merz made a radical shift in fiscal policy. Driven by the sudden withdrawal of US aid to Ukraine and the need to form a coalition with the Social Democrats, he pushed for a reform of the debt brake and a fund of 500 billion euros for infrastructure and climate. Markets and analysts became more optimistic, and expectations of reforms that would favour growth led some to predict a strong rebound, with a growth forecast for 2026 rising to around 1.3% in April 2025 (Bloomberg consensus). However, since then, the reform momentum has disappointed and the budget plans for 2026 have reinforced criticisms that much of the unprecedented "fiscal bazooka" will be limited to plugging budgetary holes. These criticisms are valid but will not prevent a strong boost to activity in 2026.
After prolonged negotiations, the three centrist parties in the outgoing German Parliament (CDU/CSU, SPD, and the Greens) agreed on March 18, 2025, on a historic reform of the debt brake and the creation of a significant fund for infrastructure and climate. Firstly, all defence spending above 1% of GDP will be exempt from the debt brake, which corresponds to about 44 billion euros based on the nominal GDP of 2024. Secondly, the federal states will no longer be required to maintain balanced budgets and may incur annual debt of up to 0.35% of GDP, which is approximately 15 billion euros. Thirdly, a special fund of 500 billion euros for infrastructure and climate neutrality (SVIK) will be created over twelve years. Of this amount, 100 billion euros will be allocated to the federal states.
“According to the Defence planning, accumulated spending in 2025-29 (exempt from the debt brake) will amount to between 580,000 and 700,000 million, with an upward risk if the Defence target of 3.5% is reached sooner than expected”
Assuming Germany meets the new NATO defence target of 3.5% of GDP, defence spending will increase significantly in 2026, reflecting both the additional fiscal margin and the existing special fund (Sondervermögen Bundeswehr). Furthermore, SVIK spending will increase significantly in 2026. These increases will amount to 44 billion euros, which represents approximately 1% of German GDP. In the coming years, this fiscal boost will stabilise but will remain clearly favourable. This trend remains unchanged when considering the items in the "normal budget".
The total additional spending in the medium term depends on whether the special defence fund (126 billion euros for 2025-2029) is fully included. According to the current planning of the Ministries of Finance and Defence, accumulated spending in 2025-2029 would amount to between 580 billion and 700 billion euros, with upward risks if the defence target of 3.5% is reached sooner than expected. If the borrowing margin of the federal states is added – which is assumed to be used in full (91 billion euros) – total fiscal expansion could reach around one trillion euros by 2030.
STRONG EFFECTS ON POTENTIAL GROWTH…
The effects on potential growth are considerable, especially given that German public capital has stagnated, limiting growth. The significant gap in public infrastructure investment, estimated at around 600 billion euros, could be significantly reduced, if not completely closed. The package allows private companies, such as construction firms, to invest in the necessary capacity and provides defence contractors with stable demand prospects. Simulations of these "bazooka effects" point to significant growth between 2026 and 2030: the European Commission's Quest model estimates an annual boost of between 0.2 and 0.4 percentage points, while some market participants are more optimistic; Goldman Sachs, for example, revises medium-term growth upwards by approximately 0.4-0.6 percentage points compared to pre-reform expectations.
…BUT LEGAL GAPS WILL REDUCE ITS EFFECTIVENESS
Although there is broad consensus on the considerable growth potential, there remains skepticism about whether the funds will be used effectively or simply serve as additional budgetary backing. In particular, SVIK is criticised for providing limited additional investment that genuinely fosters growth while significantly increasing debt.
“There is a certain shell game that shifts investment items from the federal basic budget (92.6 billion) to the special fund”
Firstly, the principle of additionality is systematically diluted. The Institut der deutschen Wirtschaft (economic research institute based in Cologne, IW) estimates that between 2025 and 2029, between 40% and 49% of the new debt will not finance additional investments (up to 133 billion euros), and even the most optimistic benchmarks imply a non-additional use of around 26%. The German Council of Economic Experts (SVR 2025) also calculates very low additionality (~8% in 2025, ~45% in 2026; 50% from then on). Secondly, the 10% investment quota established by law for the normal budget, which is supposed to prevent mere outsourcing of investment activity to supplementary budgets, is weak and methodologically distorted (IW): it counts defence investment in the numerator but excludes it from the denominator, inflating the ratio by ~0.5 pp (~2.3 billion euros). The planned figures, rather than the results, further obscure the persistent underutilisation and the surpluses of between 17 billion and 20 billion euros per year (SVR).
Thirdly, a "shell game" shifts items between the basic budget and SVIK. Compared to the previous plan, investment from the federal basic budget is reduced by 92.6 billion euros (2025-2028), while SVIK is replenished (SVR). Fourthly, the declared "investment" contains large volumes of loans, guarantees, and transfer provisions; classic construction/infrastructure has an increasingly smaller share in the basic budget (ifo). Fifthly, transparency and governance are weak: titles are renamed or double-counted, and oversight lacks binding powers (SVR).
“According to IW, 40-50% of the new debt will not finance additional investments. The Council of Experts also calculates very low additionality (8% in 2025, 45% in 2026 and 50% onwards)”
Sixthly, the rules for the Länder and municipalities are too lax: 40% of the resources from SVIK are not subject to strict additionality (SVR, IW), and municipalities recorded a deficit of 24.8 billion euros in 2024; SVR recommends a transfer of 60-70% to municipalities and moderate co-financing with safeguards. Seventh, the macroeconomic effects are modest under the current political trajectory: by 2030, 426 billion euros (real) of additional spending only generates about 246 billion euros of additional GDP; a trajectory with a higher weight of investment would yield better results (SVR). Eighth, "exemption" practices in defence distort the investment ratio and increase debt without proportional growth (SVR). Ninth, certain accounting decisions (e.g., accounting for defence, transferring subsidies to carbon-intensive regions, and transferring transport and broadband to a special purpose entity) are formally compliant but economically weak (IW).
EUROPEAN FISCAL RULES, A MEDIUM-TERM CONSTRAINT
In light of these deficiencies, we agree with the ifo conclusion that the basic budget for 2026 underscores the trend: greater dependence on debt, fewer genuine infrastructure items, and continued outsourcing outside the budget. In the medium term, this will not only deteriorate the country's debt trajectory but will also pose a collision risk with EU fiscal rules. The key feature of the reformed Stability and Growth Pact is a net spending trajectory specific to each country based on an analysis of debt sustainability, maintaining the 3% reference deficit and the 60% debt threshold (at the Treaty level), medium-term structural fiscal plans (MTFSP), covering four to five years, extendable to seven years with reforms/investments, and oversight of public administrations, including off-budget funds like the German SVIK.
“The macro effect is modest: by 2030, an additional spending of 426 billion (real) only generates about 246 billion of additional GDP”
However, the EC backed Germany's fiscal package considering that its debt ratio (63% in 2025) only slightly exceeds the 60% threshold, that it is currently a low-risk country in terms of debt sustainability and that this allows for a gradual and concentrated adjustment path at the end of the period. That said, SVR and a Bruegel study show that fully utilising the fiscal margin granted long-term by the reformed national debt brake is incompatible with EU debt rules, which could cause the debt ratio to rise to between 90% and 100%. With proper use of the bazooka money, we expect the debt ratio to rise to around 70% by 2030, which we consider an exaggerated figure. But it is clear that the less the bazooka money is used for investment and thus to improve productivity, the sooner a clash with European fiscal rules will occur.
HOWEVER, A HUGE FISCAL BOOST TO RECOVERY IN 2026
Although it is unlikely that the full growth potential of the fiscal bazooka will be realised, the budget for 2026 implies a strong fiscal boost that should significantly support activity. As the economy continues to face multiple challenges – deglobalisation, high energy prices, and intensifying global competition – industrial production has stabilised at low levels and continues to lag behind that of its European counterparts. At the beginning of 2026, the composite PMI has only recovered to the level of November and remains close to its historical norm, while the ifo index is still well below average. After three years of recession, excess capacity is considerable: the output gap for 2026 is clearly negative, ranging from -0.9% (IMF) to -2.0% (Oxford Economics). Capacity utilisation stands at 78% in industry (compared to an average of 83%) and 67% in construction, about 9 percentage points below normal. In this context, we expect the fiscal boost of 1.2 percentage points to strongly drive growth. With estimated fiscal multipliers between 0.3 and 0.7, this implies additional growth of between 0.4 and 0.8 percentage points; given the large output gap and low utilisation in the sectors targeted by the stimuli, we expect the multiplier to be at the upper end.
THE STIMULUS IS ALREADY IN MOTION.
Central government spending has increased significantly since September 2025, with a year-on-year increase of 116 billion euros (+7.5%). Spending from SVIK reached 24 billion euros in 2025, below the 37 billion forecast, but is expected to recover alongside the 58 billion forecast for 2026. National industrial orders are increasing (+7.9% month-on-month in December); although partly due to recovery investment and one-off effects, they are also supported by bazooka-related spending, particularly defence acquisitions and investments in infrastructure and railways. National orders (+10.7% month-on-month in December) surged to a level not seen since July 2021. Similarly, public construction orders are increasing and should translate into a higher volume of production. GDP in the fourth quarter of 2025 surprised on the upside (+0.3% quarter-on-quarter), supported by both household and government consumption. Overall, there are clear signs that the fiscal bazooka is gaining ground. Assuming the current momentum is maintained and accelerated with fiscal support, we forecast GDP growth of 1.2% in 2026, slightly above the 1.1% marked by the consensus. That said, sustained growth will require effective use of the funds alongside structural reforms, such as reducing bureaucracy and improving external competitiveness; otherwise, the bazooka risks being merely an illusion. ♦