Germany is set for a major shift in its economic and defense policies after the parties negotiating to form the next government agreed to amend borrowing rules and establish a €500 billion

($536 billion) infrastructure fund. The move aims to strengthen the country’s military capabilities and stimulate economic growth.

The conservative CDU/CSU bloc, led by Friedrich Merz, and the Social Democrats (SPD) are set to present their proposals to the German parliament next week. This initiative comes as the transatlantic alliance faces uncertainty following Donald Trump's return to the White House. Trump's recent decision to freeze military aid to Ukraine has raised concerns that he may negotiate a settlement with Russia, potentially reducing U.S. engagement in Europe.

Germany’s economy has faced challenges in recent years, including rising energy costs and increasing competition from Chinese car manufacturers. Economists and investors have long urged the government to reform the constitutionally imposed "debt brake" to free up investment and revitalize an economy that has contracted for two consecutive years.

A Paradigm Shift in German Defense

“In light of the threats to our freedom and peace in Europe, we must adopt a 'whatever it takes' approach to our defense,” said Merz, the likely next chancellor. He emphasized the need to strengthen Germany’s national and alliance defense capabilities, while also expressing hope that the United States would continue to honor its commitments.

Following the announcement, the euro reached its highest level in nearly four months, while Germany’s blue-chip stock index surged by 3.4%. Shares in European defense companies have also risen sharply in anticipation of increased military spending across the region.

Berenberg economist Holger Schmieding described the proposed fiscal shift as “a really big bazooka,” signaling a significant change in Germany’s traditionally conservative financial policies. The CDU/CSU and SPD plan to introduce a motion in parliament to amend the constitution, allowing defense spending exceeding 1% of GDP to be exempt from the debt brake.

Additionally, a panel of experts will develop proposals to modernize the debt brake, ensuring long-term investment in key sectors. A recent poll by INSA found that 49% of Germans support easing borrowing restrictions, while only 28% oppose the measure. However, passing the reforms will require a two-thirds majority in parliament.

Political Challenges and Urgency

The urgency to pass these measures stems from the recent election results, which saw far-right and far-left parties gaining enough seats to form a blocking minority in the new parliament. The radical Left party has already threatened legal action if Germany increases its debt for military spending.

The Greens, whose support is crucial for passing the reforms, have expressed openness to reviewing the proposals but have not yet committed to backing them.

“If this succeeds, Germany’s economic stagnation could end quickly,” said Sebastian Dullien of the IMK Institute. “Germany will once again be both economically and militarily capable of taking decisive action.”

Merz is also scheduled to meet outgoing SPD Chancellor Olaf Scholz to discuss additional aid for Ukraine, with more than €3 billion in potential support under consideration.

Germany has faced mounting pressure from the United States to boost its defense budget and modernize its military, which has been underfunded since the end of the Cold War.

“This represents one of the most historic paradigm shifts in Germany’s postwar history,” said Robin Winkler, an economist at Deutsche Bank. Photo by Avij, Wikimedia commons.