Germany’s U‑turn proves Europe’s fiscal framework must change

In a historic shift, the German government has officially reformed its stringent debt brake (Schuldenbremse). After years of underinvestment and economic stagnation concerns, Berlin has decided to increase public spending, particularly in defence, infrastructure and climate projects. The German stock market responded enthusiastically, soaring to record highs, showing investor optimism for a long-overdue boost to growth and productivity

Yet, there is a fundamental contradiction at the heart of this move: Germany’s new fiscal trajectory is at odds with the European Union’s (EU’s) fiscal rules. With Germany’s debt now set to rise continuously rather than fall, the country’s new approach cannot be squared with EU requirements. With Germany historically supporting strict fiscal rules, its latest stance provides an opportunity for Europe to break free from rules that have prevented it from building stronger, more resilient and more sustainable economies and societies.

Why Germany changed course

Germany’s decision to loosen the debt brake reflects wider economic and geopolitical pressures. Likely new chancellor Friedrich Merz, from the conservative Christian Democratic Union (CDU), has justified the shift by pointing to the breakdown of transatlantic relationships, growing geopolitical instability and the need for more defence spending.

As the reforms required a two-thirds majority, the Greens played a crucial role in securing them, despite Merz blocking similar changes when they were in government. In exchange, they want substantial progressive changes. These include a requirement that all investments under the new infrastructure fund must be additional to investments that are already planned.

Since 2009, Berlin has limited structural deficits — the country’s permanent borrowing- to 0.35% of GDP annually outside crises. This constrained investment in critical infrastructure, digitalisation, and industrial competitiveness.

However, a series of crises exposed the weaknesses of this model. The COVID-19 pandemic forced Germany to temporarily suspend the debt brake, while the Russian invasion of Ukraine underscored the importance of speeding up the transition to renewables. Additionally, Germany faces major investment needs in in public services, industrial modernisation and climate resilience. Business leaders and industry groups have also backed greater investments, arguing that modern infrastructure and green technology are essential for long-term economic stability.

Under the revised framework, Germany will significantly increase public investment over the next decade. Defence spending above 1% of GDP will now be excluded from borrowing limits and a new €500 billion off-budget mechanism will fund new infrastructure projects, with €100 billion earmarked for climate investments. Moreover, all investments need meet the objective of climate neutrality by 2045. Rules limiting borrowing by federal states have also been loosened slightly. While this is likely not enough to meet the huge climate investment gaps, it is a step in the right direction. Indeed, Robin Winkler, chief German economist at Deutsche Bank Research said: ​“In our view, this is a historic fiscal regime shift, arguably the largest since German reunification”.

German fiscal rules at odds with EU fiscal rules

However, Germany’s policy shift raises serious questions for the EU’s fiscal framework. For years, countries like France, Italy, and Greece have struggled under rigid EU debt rules. Now, Germany itself is breaking them.

According to Bruegel, Germany’s new fiscal strategy directly contradicts EU rules. The revised framework requires countries with debt above 60% of GDP to reduce it within seven years. However, Germany’s debt, currently 67% of GDP, will rise continuously. To stay within the EU fiscal rules, Germany will have to reduce its deficit every year, but new spending will result in annual deficits to increase.

Germany breaking the EU fiscal rules, as well as changes to allow for more defence spending, risks undermining the credibility of the framework itself. While the existing rules are overly rigid and don’t allow the scale of public investment that are needed, a coherent and effective set of fiscal guidelines remains crucial for the stability of the Euro area. The most logical path forward is to reform the EU’s fiscal rules to reflect current economic, geopolitical and environmental realities.

One option would be to raise the 60% debt threshold. NEF has long argued that arbitrary fiscal limits (60% debt-to-GDP, 3% deficit) should be revised, but this would require treaty reform — a politically difficult task.

Another approach is to allow more flexibility for productive investments. A recent NEF report shows higher fiscal multipliers for green and industrial investment lead to stronger growth and fiscal sustainability. A green golden rule or an exemption for high-multiplier investments could be a workable alternative.

“The real challenge now is whether this change allows the EU to adapt to this new reality, or whether outdated rules will continue to constrain Europe’s economic potential”

Meanwhile, there is also a broader European approach to fiscal expansion. The Draghi report has already provided a blueprint for large-scale public investment, estimating that €800 billion in additional investment is needed to modernise Europe’s economy. To meet this need, Draghi argues that the EU must collectively borrow to fund a European investment fund. A similar approach was agreed during the Covid-19 pandemic, but this money will run out in 2026. The sooner such a fund can be agreed, the more investor certainty can be given.

The German government should see this is also in their own economic interest. Germany’s economic model has long relied on exports, but with the US turning more protectionist and China importing less, external demand is no longer a reliable growth engine. Allowing greater productive investments across the EU, would increase domestic and European demand, including for German-made products.

For years, Germany argued for strict debt rules. Now, Berlin is breaking those very rules. The question isn’t whether fiscal policy should change — it already has. The real challenge now is whether this change allows the EU to adapt to this new reality, or whether outdated rules will continue to constrain Europe’s economic potential. One way or another, Europe’s fiscal future is about to be rewritten.

The UK government should also pay attention. While the previous German government was constrained by strict fiscal rules and lacked a majority to change them, the UK government is imposing restrictions on itself. Instead of using the current crisis to justify investment and reform, it clings to budget cuts that will sap growth and weaken re-election chances. The CDU, architects of Europe’s strictest debt rules, spent years lecturing on fiscal restraint. But now, faced with reality, they have dropped their rigid orthodoxy and embraced investment. The UK government has the power to change the rules but seems intent on handcuffing itself to outdated thinking. If even the CDU can adapt, what is the UK waiting for?

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