The parties hoping to form Germany’s next government have agreed to overhaul borrowing rules and create a €500 billion ($536 billion) infrastructure fund in a tectonic spending shift to revamp the military and revive growth in Europe’s largest economy.
Friedrich Merz’s conservatives and the Social Democrats (SPD), who are in negotiations to form a coalition after a national election last month, will put their proposals to the German parliament next week.
Merz, Germany’s likely next chancellor, has seized the moment after the return of Donald Trump to the White House put the transatlantic alliance in turmoil and underlined the urgency for Europe to strengthen its own defenses.
Trump froze military aid to Ukraine after a bitter clash last week with its President Volodymyr Zelenskiy, reinforcing fears he could strike a deal with Russia to end the war in Ukraine while disengaging from Europe.
Economists and investors have urged Germany to reform its constitutionally enshrined state borrowing limits — known as the “debt brake” — in order to free up investment and support an economy that has contracted for the past two years.
“In view of the threats to our freedom and peace on our continent, whatever it takes must now also apply to our defense,” Merz, leader of the CDU/CSU conservatives, said Tuesday.
“We are counting on the United States of America to continue to stand by our mutual alliance obligations in the future. But we also know that the resources for our national and alliance defense must now be significantly expanded.”
The euro rose to its strongest level in nearly four months Wednesday after the news. Germany’s blue-chip share index jumped 3.4% as of 4.30 a.m. ET to trade near a record high.
European defense company shares have soared in recent days as momentum to ramp up spending across the region gathers pace.
“A really big bazooka,” wrote Berenberg economist Holger Schmieding, commenting on the German measures. “These proposals for an immediate loosening of Germany’s fiscal rules will likely be enacted. They are a fiscal sea change for Germany.”
Merz said the CDU/CSU and SPD would submit a motion to the Bundestag lower house of parliament next week to amend the constitution so defense expenditure above 1% of economic output is exempt from the debt brake.
A commission of experts will separately develop a proposal for modernizing the debt brake to boost investments on a permanent basis.
According to a poll by INSA, 49% of Germans support loosening the debt brake while only 28% are against. But changing the debt rules and creating a special fund require a two-thirds majority in parliament.
The conservatives and SPD are rushing to get the moves passed in the outgoing parliament, given far-right and far-left parties will have a blocking minority in the new parliament after scoring strongly in last month’s election.
The radical Left party had already threatened a legal challenge if Germany takes on new debt to fund defense expenditure.
The Greens party, whose support is needed to get the debt brake reform across the line, said it would look at the proposals but made no firm commitment.
“If this succeeds, then the stagnation of the German economy is likely to be overcome quickly,” said Sebastian Dullien of the IMK institute. “Germany is once again economically and militarily capable of taking action.”
Merz said he would meet outgoing SPD Chancellor Olaf Scholz Wednesday to discuss additional aid for Ukraine, with more than €3 billion on the table.
“Our country is running on wear and tear, and that is why it was important for us to invest, to invest massively, so that our country functions better again,” SPD leader Lars Klingbeil said.
The United States has repeatedly pressured Germany to increase its defense spending to overhaul a military that has felt neglected since the end of the Cold War and diverted weapons to support Ukraine in the war against Russia.
“Pending more clarity on this issue and being mindful of some execution risk, we believe this is one of the most historic paradigm shifts in German postwar history,” said Robin Winkler, an economist at Deutsche Bank.