Germany's fiscal pivot fails to deliver the growth Europe was promised

Germany was supposed to be the engine that pulled the eurozone out of its slump. A historic rewrite of the debt brake, a half-trillion-euro investment fund, and a surge in defence orders all pointed to a fiscal turning point. Six months later, the data tells a different story. The economy shrank 0.3% in the second quarter of 2025 after a marginal 0.3% gain in the first, leaving annual growth flat. The eurozone as a whole expanded just 0.1% in the same period. The gap between political ambition and economic reality is widening.

The reform that was meant to change everything

In early 2025, Berlin amended the constitutional debt brake that had capped the federal structural deficit at 0.35% of GDP since 2009. The new rules exempt defence and security spending above 1% of GDP from the limit, a direct response to the changed security environment after Russia's full-scale invasion of Ukraine. Alongside the amendment, the government established a €500bn special fund for infrastructure and climate investment, financed through borrowing outside the regular budget. At the time, the package was described as a potential game-changer for an economy that had contracted in both 2023 and 2024.

The political logic was clear: Germany's infrastructure backlog, estimated at hundreds of billions of euros by the Bundesbank, and decades of underinvestment in digital and transport networks required a fiscal shock. The defence exemption acknowledged that NATO's 2% target could not be met without breaking the old rules. But the mechanics of turning legislative headroom into cranes on building sites and tanks on training grounds have proved slower than the rhetoric suggested.

Orders are rising but output is not following

Holger Schmieding, chief economist at Berenberg, confirms that a "major rise" in defence orders and infrastructure investment has started. The problem, he says, is that "we are not seeing it strongly in actual output data yet." German procurement cycles, planning permissions, and a construction sector already stretched by labour shortages mean that money authorised in Berlin takes months or years to appear in GDP. "In Germany, it takes time to spend money," Schmieding adds. His modelling suggests the fiscal stimulus will eventually add around 0.3 percentage points to German growth in 2026, lifting the eurozone by 0.1 points, a measurable but modest contribution.

The Federal Statistical Office data underscores the lag. Gross fixed capital formation in machinery and equipment fell in the first half of 2025, while construction investment barely moved. Defence procurement, while rising in nominal terms, involves long lead times; the first significant deliveries from the new framework are not expected until late 2026 at the earliest. The infrastructure fund, meanwhile, has only begun disbursing its first tranches, with the bulk of projects still in the planning stage.

Where the money is actually going

Franziska Palmas, senior Europe economist at Capital Economics, highlights a less discussed dimension of the fiscal expansion. "The government is not just raising defence and infrastructure spending," she says. "It is also using some of the additional fiscal space to finance other spending." That includes electricity tax cuts for energy-intensive industries, but also higher pension, healthcare and social benefit costs driven by demographics. "Things like electricity tax cuts still will have a positive effect on the economy," Palmas notes, "but the additional spending on healthcare and pensions won't boost the economy given it reflects mainly rising costs due to demographics."

This distinction matters. The debt brake reform created room for borrowing, but the government has chosen to allocate a significant share to current expenditure rather than capital formation. Pension spending alone is projected to rise by more than €30bn annually by 2028 as the baby-boom cohort retires. Healthcare costs are on a similar trajectory. While these outlays support household income, they do not expand the economy's productive capacity in the way that bridges, broadband, or defence equipment might. The result is a higher structural deficit, Palmas warns of a "much higher deficit" over the coming years, without a commensurate growth dividend.

Forecasts converge on modest growth

The major German economic institutes, DIW, Ifo, IfW, IWH and RWI, have recently cut their joint 2026 forecast to just over 1%. The European Central Bank sees the eurozone growing 1% next year, a figure that assumes the German stimulus feeds through gradually. Capital Economics is slightly more optimistic on the spillover, estimating Germany adds 0.2 percentage points to eurozone growth in 2026, but Palmas cautions that "the expansion may not be as strong as many economists are anticipating." The divergence between the 0.1 and 0.2 point estimates reflects different assumptions about the speed of disbursement and the import content of German demand.

Neither figure is transformative. An economy the size of Germany's growing at 1% adds roughly €40bn in annual output. For the eurozone, the direct fiscal impulse from Germany is a rounding error against a €15 trillion bloc. The bigger question is whether the confidence effects Schmieding mentions, "modest positive confidence effect on its neighbours", can amplify the direct impact. Germany remains the largest trading partner for most eurozone members, so a sustained German recovery would lift export orders across the region. But confidence is a fragile transmission channel when the hard data remains weak.

Other forces shaping the eurozone outlook

Germany does not operate in a vacuum. The ECB's rate cuts, 100 basis points since June 2024, are starting to ease financing conditions, though the lag means the full effect will not be felt until 2026. Spain continues to outperform, driven by immigration-fuelled labour supply growth and a tourism boom; its economy expanded 0.8% in the second quarter. On the drag side, Palmas estimates US tariffs will subtract around 0.2 percentage points from eurozone GDP, while France's fiscal tightening, required to bring its deficit below 3% of GDP under the revised Stability and Growth Pact, will weigh on domestic demand. The net picture is one of offsetting forces, with Germany's fiscal push barely outweighing the headwinds.

The Eurostat flash estimate for the second quarter showed the eurozone's investment rate stuck at 22% of GDP, below the pre-pandemic average. Private sector credit growth remains anaemic. Until those indicators turn, the region remains dependent on fiscal policy to avoid stagnation. Germany's contribution, while necessary, is not sufficient.

Why the debt brake reform matters beyond 2026

The structural shift in German fiscal policy is real, even if the near-term growth payoff is smaller than hoped. The debt brake amendment and the special fund represent a permanent increase in the state's capacity to borrow for investment. That changes the baseline for German public debt, which the Bundesbank projects will rise from 63% of GDP in 2024 to around 70% by 2028. For a country that has treated the black zero as a article of faith, this is a regime change. The question is whether the investment share of that borrowing rises fast enough to justify the higher debt trajectory.