What does German debt brake reform mean for Europe?

On March 21, 2025, Germany approved a historic constitutional amendment to its national fiscal rule, the ‘debt brake’. Defence spending above 1% of GDP will not be subject to any borrowing limit. The amendment also creates a €500 billion extrabudgetary fund for additional infrastructure spending, €100 billion of which is earmarked for climate-related investment. The fund must be spent within 12 years.

This is good news for Germany and for Europe. German debt will rise, but remain sustainable. Assuming nominal growth of 2.5-3% and longer-term military spending of 3-3.5% of GDP, it should converge at around 100% of GDP. Europe will benefit from demand effects, higher German defence capability (helping to deter Putin) and reduced emissions. Real interest rates in the euro area could also rise, and may have risen by about 30 basis points. This is bad for government borrowing costs, but creates room for the European Central Bank to cut interest rates in a downturn.

However, the debt brake amendment creates two complications at a European level. These are serious, but can be addressed.

First, European Union fiscal rules make it impossible for Germany to execute its spending plans. Using the ‘national escape clause’ to exclude up to 1.5% in military expenditure from the rules would allow Germany to modestly raise defence spending, but prevent it from spending its infrastructure fund. To allow higher German spending, the rules may have to change, for example by setting the ‘reference value’ for debt from 60% to 90% of GDP. The fact that this would be triggered by a policy change in Germany is unfortunate. But it would be good for all of Europe.

Second, German military spending may exacerbate fragmentation of the European defence industry. Germany may want to maximise economic benefits by mostly spending domestically. From a defence and EU perspective, this makes no sense. With limited national supply, spending primarily on the domestic industry will mainly drive up costs.

To ramp up defence capabilities at acceptable cost, Europe must pool procurement. And it should do so quickly. Bruegel will have more on this in coming weeks.

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