Macro & Oil Report: Germany puts budgetary austerity on hold and drags Europe in its wake

Europe’s Economic Shift: Germany’s €1 Trillion Defense and Infrastructure Plan Amid US Policy Changes

In a dramatic policy reversal that signals a new era for European economic strategy, Germany has approved a constitutional amendment enabling approximately €1 trillion in defense and infrastructure spending over the next decade. This landmark decision, influenced by changing US-European relations under the Trump administration, could reshape Europe’s economic and security landscape for years to come.

Germany’s Constitutional Amendment: Breaking the Debt Brake

The German Bundestag recently voted to amend the country’s constitution, effectively modifying the stringent fiscal rules established in 2009. This unprecedented move will allow the incoming government to allocate approximately €1 trillion—roughly 2% of GDP annually over the next 10-12 years—toward defense capabilities and infrastructure modernization.

Chancellor-in-waiting Friedrich Merz, who had previously opposed constitutional changes, justified this dramatic shift by the Trump administration’s position on trans-Atlantic security relationships and European defense spending. The amendment required a two-thirds parliamentary majority and was pushed through before the newly elected parliament takes office. This manoeuvre raised questions about its legitimacy but appears to have broad public support.

Trump’s Influence on European Defense Policy

Since Donald Trump’s return to the White House, several key events have convinced European leaders that the transatlantic security relationship has deteriorated:

• Trump’s persistent criticism of European NATO members for insufficient defense spending,
• Unofficial suggestions from Elon Musk about potential US withdrawal from NATO,
• Vice-President J.D. Vance’s speech in Munich, which was highly critical of European leaders,
• The Ukrainian president’s visit to the White House, which reinforced concerns about the US position vis-à-vis Russia.

These factors, combined with growing security threats, have pushed European nations—particularly Germany—to reconsider their defense posture and spending priorities.

Beyond Defense: Economic Revival Through Infrastructure Investment

While defense concerns triggered the policy shift, Germany’s massive spending plan extends well beyond military capabilities. The economic component addresses Germany’s prolonged economic stagnation, which has certainly contributed to the rise in political extremism:

• Recent German elections saw significant gains for far-right (AfD) and far-left (Die Linke) parties,
• The traditional parties of the governing coalition suffered heavy defeats,
• Germany has experienced economic contraction for two years, zero growth for five years, and less than 1% growth over the past decade.

The new spending plan allocates substantial resources to infrastructure development, including:

• €100 billion specifically dedicated to energy transition projects (a concession to Green party supporters),
• Funding for hospitals, schools, roads, and energy networks,
• Regional development through €100 billion in spending managed by German Länder (states).

Breaking Free from Austerity: The End of the Debt Brake Era?

The constitutional amendment effectively loosens Germany’s infamous “debt brake” (Schuldenbremse) rules established in 2009 following the global financial crisis. These rules limited the federal structural deficit to 0.35% of GDP and prohibited deficits for the Länder.

While this policy successfully limited Germany’s debt (currently just over 60% of GDP compared to nearly 100% for other eurozone countries), it has come at a significant economic cost. For around 10 years, Germany’s growth has always been 1 to 1.5 points lower than that of the other countries in the euro zone

The new rule specifies that defense spending exceeding 1% of GDP (approximately €45 billion) will no longer be subject to the strict fiscal limitations implemented in 2009, marking a fundamental shift in German economic philosophy.

European Commission’s Complementary Initiatives

Germany’s policy shift coincides with ambitious European Commission proposals to boost collective defense capabilities:

• A proposed €150 billion joint loan to finance EU defense efforts,
• Relaxation of budgetary discipline by excluding up to €650 billion in defense spending from deficit calculations over four years,
• Potential restrictions on using these funds for purchases from non-EU countries (US, UK, Turkey) without defense cooperation agreements.

These initiatives complement Germany’s national efforts but raise complex questions about implementation, particularly regarding how quickly Europe can build domestic defense production capacity when two-thirds and three-quarters of military spending flows to imports.

Economic Impact and Market Response

The market response to these policy shifts has been dramatic, especially when contrasted with US market performance:

• While the seven leading US technology stocks fell by 16% and bitcoin lost 21%, gold gained 12% over the same period. But this is nothing compared to European stocks in the defence sector. For example, the German arms manufacturer Rheinmetall has seen its share value jump by 87% since 20 January 2025, and by 180% since the election of Donald Trump in November 2024,
• The interest rate differential between US and German 10-year bonds has narrowed by a third (from 210 to 145 basis points),
• The euro-dollar exchange rate has strengthened from 1.03 to 1.09.

Economic forecasts suggest Germany’s growth could increase by almost 1% point from 2026, with positive spillover effects for other European economies. However, these benefits could be partially offset by negative impacts from escalating global trade tensions.

Challenges and Uncertainties Ahead

Despite market optimism, significant challenges remain for implementing this ambitious policy shift:

• Sustaining public support for defense spending if it requires cuts to social programs,
• Building sufficient domestic defense production capacity to reduce import dependence,
• Managing potential conflicts between rapid rearmament needs and preferences for European suppliers,
• Balancing fiscal expansion with long-term debt sustainability concerns,
• Navigating complex relationships with non-EU defense partners like the UK.

Conclusion: A New Chapter in European Economic Policy?

Germany’s trillion-euro spending plan represents a fundamental readjustment of its economic policy. The shift away from fiscal restraint in favour of strategic investments – motivated by both security concerns and economic necessities – could mark the beginning of a new era in European economic policy.

While the markets have reacted positively to this spectacular turnaround, the long-term economic impact remains uncertain. Apart from Germany, the budgetary leeway of the other European countries is small or even non-existent, which could mean making painful choices that will not necessarily have the support of the population.