German Parties Propose a Historic Overhaul of Spending, Defense Policies

(DAVID GANNON/AFP via Getty Images)

A German flag flies above the Reichstag, the building that houses the Bundestag, on July 23, 2022, in Berlin.

If approved, Germany's constitutional reforms and unprecedented fiscal stimulus would represent a historic transformation in its defense and economic strategy, unlocking massive military spending, providing greater flexibility to increase aid to Ukraine, and revitalizing the country's economy while boosting growth across neighboring countries. Christian Democratic Union (CDU) leader and Germany's likely next Chancellor, Friedrich Merz, announced on March 5 that he had reached an agreement with his prospective coalition partners to significantly boost funding for the country's military and infrastructure and relax constitutional government borrowing limits for defense and security spending. Just over a week after winning the Feb. 23 federal elections, Merz said the CDU and its Bavarian sister party, the Christian Social Union (CSU) — along with their likely coalition partner, the center-left Social Democratic Party (SPD) — will propose constitutional amendments to establish a 500 billion euro ($528 billion) infrastructure fund to finance investments in transportation, energy grids and housing over the next decade and to exempt defense expenditures exceeding 1% of GDP from Germany's so-called ''debt brake,'' a constitutional rule that restricts government borrowing and limits the structural deficit to 0.35% of GDP. The agreement also includes provisions to relax fiscal constraints on regional states.

Germany is also reportedly urging the European Union to revise its fiscal rules, calling for greater flexibility for increased defense spending without breaching EU budget constraints in light of Europe's growing geopolitical challenges. On March 4, the European Commission proposed activating an ''escape clause'' in the bloc's Stability and Growth Pact (which caps national debt at 60% of GDP and deficits at 3%) to temporarily ease fiscal limits for defense investments. However, Germany is reportedly calling for even broader, long-term flexibility in defense spending.

Merz's push to ramp up defense and infrastructure investment comes amid economic challenges and uncertainty over U.S. support for Ukraine and European security. The announcements follow U.S. President Donald Trump's March 4 decision to suspend all military aid to Ukraine and come a broader retreat in U.S. commitments to Europe's defense. Against this backdrop, EU leaders are working to unlock billions of euros in additional defense funding for Ukraine to compensate for the anticipated reduction in U.S. support and strengthen both national and collective defense spending. The move also aims to provide stimulus to Germany's ailing economy (with GDP contracting by 0.3% in 2022 and by 0.2% in 2024) and reverse years of underinvestment. To pass his proposals, Merz needs a two-thirds majority in parliament, which will be much easier to achieve in the outgoing Bundestag compared with the newly elected Bundestag set to take office later this month. Securing support from the Greens — who are unlikely to be part of the next coalition but favor easing fiscal rules for defense and infrastructure — will be key to bypassing resistance from the far-right Alternative for Germany (AfD) and far-left Die Linke, which will have enough seats in the new Bundestag to block the measures. With the outgoing parliament active until March 25, Merz thus has a brief window to push through the proposed constitutional amendments, with two special parliamentary sessions already scheduled for March 13 and 18. The agreement also sets the foundation for a broader coalition deal between the CDU/CSU and the SPD as, by resolving key financial issues early, both parties will avoid potential obstacles in formal negotiations, which will likely last several weeks.

Merz is expected to present his proposals to the Bundestag next week, meaning the measures would not be conditional on successful coalition talks between the CDU/CSU and the SPD.
In the current 733-seat Bundestag (which emerged from the 2021 federal election), the CDU/CSU, the SPD and the Greens together control 521 seats, granting them the two-thirds majority needed to pass constitutional reforms. However, these three parties will only control 413 seats in the new 630-seat Bundestag (the total number of seats has been reduced starting this legislature), which will not be enough to reform the constitution. While Die Linke has spoken in favor of removing the constitutional debt brake and will have enough seats in the new Bundestag to help the other three parties change the constitution, the party is against increased military spending. Die Linke's support thus cannot be guaranteed, especially if Merz remains unwilling to make substantial concessions to the party, which explains why he is trying to reform the constitution with the outgoing Bundestag.
While the CDU/CSU, SPD and Greens will likely secure the two-thirds majority needed to pass the constitutional amendments before the new Bundestag takes office, potential political hurdles remain. Internal resistance within the CDU/CSU could pose a challenge, given the party's longstanding commitment to the debt brake, despite Merz expressing a tepid willingness to reform it on the campaign trail. Failure to pass the amendments would not only derail a key policy initiative but also weaken Merz's authority within his party before he even takes office, significantly undermining his leadership.

If approved, the proposed constitutional amendment and fiscal stimulus would mark a fundamental shift in Germany's defense and economic policies, boosting growth in and beyond the country while also increasing uncertainty over financial stability across the Eurozone. Exempting defense spending from constitutional debt limits would enable Germany to take on significant amounts of debt for military expansion and aid to Ukraine, providing additional capacity to eventually increase support to Kyiv amid growing uncertainty over U.S. financial and military aid. The policy shift would also reverse Germany's decades-long fiscal conservatism, with Berlin now pushing for greater flexibility in EU fiscal rules and increased defense spending needs across the bloc. More broadly, greater military spending — combined with the proposed 500 billion euro infrastructure fund — will provide a much-needed boost to Germany's sluggish economy by addressing years of underinvestment and offering both short-term economic support and greater long-term growth potential. Though headwinds like high energy costs, labor shortages and declining industrial competitiveness will likely persist in the short-to-medium term, this stimulus — alongside other economic measures likely to be pursued by the next government, such as tax cuts and deregulation — will help pull Germany out of economic stagnation and improve investor confidence. This will also have spillover effects benefiting the broader European economy, given the size of the German economy and its deep integration with supply chains across the Continent, particularly in neighboring Central European countries. However, despite these potential economic gains, concerns remain that loosening fiscal constraints could drive up borrowing costs in Germany and across the Eurozone, posing risks for highly indebted EU member states while testing the long-term sustainability of expanded public spending.

Markets responded positively to Merz's plans, with European equities outperforming their U.S. counterparts. The euro also rebounded over the U.S. dollar, while Germany's benchmark DAX index surged by as much as 3.8%.
However, the March 4 announcement has also unsettled bond markets, triggering a rise in German borrowing costs as investors brace for a surge in government debt issuance. Yields on 10-year German Bunds, a key benchmark for the Eurozone, jumped as much as 23 basis points to 2.73% on the news — the biggest spike since mid-2022. This reflects market fears that increased fiscal spending could strain Germany's historically disciplined budget.
The sell-off in German government bonds also rippled across Europe, driving up yields on riskier debt in Italy, France and the United Kingdom, countries that have all previously faced scrutiny over their fiscal policies. The market reaction on March 5 marked the largest sell-off in German debt since 2020, as investors anticipated a significant expansion in borrowing. Higher yields in Germany are expected to push up financing costs for sovereigns across the Eurozone, intensifying fiscal pressures on heavily indebted countries.
Still, even as the new government increases spending, Germany's relatively low debt-to-GDP ratio will ensure relative market stability in the short-to-medium term, preventing credit downgrades. But over the long term, rising government deficits and public debt levels could become a concern, particularly as demographic pressures and Germany's shrinking workforce strain fiscal sustainability. If left unaddressed, these factors could intensify structural budget challenges, gradually limiting Berlin's fiscal flexibility and increasing the risk of future spending cuts or tax hikes to maintain stability.