Germany adopted a constitutional reform of its national fiscal framework in March 2025, introducing three significant changes that could reshape its economic landscape. This blog post explores the potential economic impact of these reforms, focusing on the new infrastructure fund and its implications for growth, public debt, and European spillovers.
Three Pillars of Reform: What’s New?
The recent fiscal framework reform introduces key changes designed to address Germany’s investment needs and provide greater flexibility.
1. The EUR 500 Billion Infrastructure Fund: A Catalyst for Growth
A major novelty is the establishment of a new infrastructure fund, valued at EUR 500 billion (11.6% of 2024 GDP). This fund operates outside the scope of the “debt brake” and is earmarked for crucial projects in transport, healthcare, energy, education, research, and digitalization. Projects can be approved within 12 years, signaling a long-term commitment to enhancing Germany’s productive capacity.
2. Defence Spending Exclusion from the Debt Brake
Defence spending exceeding 1% of GDP is now excluded from the calculation of the “debt brake.” This provides more leeway for Germany to invest in its national security without facing the same fiscal constraints.
3. Increased Borrowing Capacity for the Länder
The Länder (federal states) are now permitted to take up new net borrowing of up to 0.35% of GDP annually, aligning their borrowing capacity with that of the federal level. This relaxes the previous requirement for the Länder to maintain balanced budgets, offering them greater fiscal flexibility.
Model Simulations: A Glimpse into the Future
While plans for increased spending were not sufficiently detailed to be included in baseline projections at the forecast’s cut-off date, stylized model simulations using the QUEST model offer insights into the potential economic impact.
Assuming the fund is fully debt-financed and allocated to productive projects, with a linear spending profile starting in the second half of 2025, the simulations project a considerable uplift:
- GDP Growth: Germany’s GDP could be approximately 1¼% higher by the end of this legislative term (2029) and 2½% higher by 2035 compared to the baseline. This sustained expansion is attributed to an increase in capital stock and productivity.
- Public Debt: The impact on public debt is expected to be relatively contained, provided that the investments yield high productivity gains and stimulate growth, with public spending rising below GDP growth. The debt-to-GDP ratio could be around ½ percentage point higher in 2029, increasing to 3¼ percentage points above baseline in 2035.
European Spillovers: A Wider Impact
The increase in investment within Germany is also expected to generate positive economic spillovers for other EU Member States. EU GDP could be lifted by ¾% in 2035, with roughly one-third of this impact resulting from these spillovers.
Productive vs. Unproductive Spending: A Crucial Distinction
The growth benefits of the infrastructure fund are heavily dependent on the nature of the investments.
The Impact of Unproductive Spending
To illustrate this, an alternative scenario was considered where half of the additional spending from the fund financed unproductive public consumption. In this case:
- Muted GDP Impact: The impact on German GDP would be significantly smaller, reaching ¾% of GDP in 2029 and 1¼% of GDP in 2035. This reflects a smaller increase in overall production capacity and subsequent effects on private demand.
- Higher Debt: The debt-to-GDP ratio would be approximately 1½ percentage points higher in 2029 and 5½ percentage points higher in 2035 than in the baseline.
This comparison underscores the importance of focusing on productive investments to maximize economic gains and manage public debt effectively.
Realizing the Full Potential: Addressing Bottlenecks
While the infrastructure fund offers significant economic potential, realizing its full benefits requires addressing various investment bottlenecks beyond just financing. These include:
- Labour supply: Ensuring a skilled workforce to execute projects.
- Efficiency of planning and permitting procedures: Streamlining administrative processes to accelerate project implementation.
- Institutional complexity and administrative capacity: Enhancing the effectiveness of institutions and administrative bodies involved in project delivery.
Other Reforms: Limited Immediate Impact
The new possibility for the Länder to increase their deficit and for Germany to increase defence spending outside the scope of the debt brake may have a smaller impact on economic growth. This is primarily because there is no explicit requirement to spend these two new sources of fiscal space on productive investment, unlike the infrastructure fund.
Conclusion: A Path to Sustained Growth
Germany’s fiscal framework reform, particularly the establishment of the infrastructure fund, presents a significant opportunity for sustained economic growth and enhanced productivity. However, the success of these reforms hinges on the judicious allocation of resources to productive investments and the proactive addressing of existing bottlenecks.
