Germany’s chancellor-in-waiting Friedrich Merz is considering unlocking hundreds of billions in extra funding for the country’s military and infrastructure as coalition talks with Social Democrats gather pace.
One option under review is a proposal by top German economists to raise up to €800bn in new public borrowing for two separate off-budget funds over a decade, said two people with knowledge of the matter.
A third person briefed on the early-stage negotiations said they were centred on a combined €500bn package. The people cautioned that other options could be examined.
Such a plan would mark a step-change in Germany’s traditionally conservative approach to public borrowing. Berlin in 2009 enshrined a debt brake in its constitution, which limits government borrowing and keeps the structural deficit at 0.35 per cent of GDP.
The economists’ proposal would be “a double bazooka”, said Armin Steinbach, professor of economics at HEC, referring to the term used for Chancellor Olaf Scholz’s stimulus during the Covid-19 pandemic.
The proposal would stimulate a stagnating economy and signal that the EU’s largest democracy is serious about increasing defence capabilities at a time when the US administration is seeking to unwind the transatlantic alliance.
It could be “a very big one”, said Holger Schmieding, chief economist at Berenberg. “And it looks like the negotiations are going ahead very fast and that we could get a deal fast.”
The German central bank on Tuesday argued that any reform of the debt rules should focus on creating additional fiscal space for public investment. In a policy proposal, the Bundesbank said that a more fundamental reform of the debt brake could generate up to €220bn of investment by 2030.
If Germany’s debt-to-GDP level stayed at less than 60 per cent, the government’s ability to borrow should be more than tripled from 0.35 per cent of GDP to 1.4 per cent, the bank said. Even with debt levels above 60 per cent, the Bundesbank suggested increasing the structural deficit threshold to 0.9 per cent of GDP.
The talks in Germany came as the European Commission outlined on Tuesday a joint debt instrument that would enable member states to fund military equipment.
The instrument would involve the commission borrowing on the markets against the EU budget, then lending to member states at cheap rates. It would require unanimous backing from EU countries.
The €150bn in loans could buy “air and missile defence, the artillery system, missiles and ammunition drones and anti-drone systems, but also to address other means from cyber to military mobility”, said Ursula von der Leyen, president of the commission.
She added that lifting EU fiscal rules for defence investments would enable countries to spend €650bn on defence over four years, or about 1.5 per cent of GDP on average.
Countries will also be given the chance to redirect their regional development funding to defence, and the European Investment Bank will be asked to expand defence investments.
“This is Europe’s moment and we must live up to it,” von der Leyen said.
In Germany, Merz, whose CDU/CSU conservative bloc won elections on February 23, has accelerated coalition talks with the SPD since Donald Trump publicly admonished Ukraine President Volodymyr Zelenskyy at the White House last week.
On Monday, Merz said he aimed for an agreement on defence funding with the SPD before Thursday, when EU leaders meet to discuss Ukraine and the continent’s security.
“From my point of view, the urgency is great,” he said, declining to comment on the two-fund proposal. “We should try to agree on this before the EU summit on Thursday.”
Merz declined to comment on the instruments or figures, saying: “That’s all open.”
Germany’s next chancellor has signalled he wants to use the outgoing parliament’s supermajority to pass the constitutional amendments that such borrowing would require, because his government would probably be blocked by the far-right Alternative for Germany and far-left Die Linke in the next parliament.
The outgoing parliament can be reconvened in an extraordinary session until March 25.
Speaking ahead of exploratory talks with the CDU/CSU, SPD co-leaders and negotiators Lars Klingbeil and Saskia Esken suggested on Monday they would request more funding for transport and energy infrastructure, which experts have said requires investment of about €600bn.
“Are we able to answer even the big questions now? This certainly includes the issue of external security and our country’s defence capabilities. But this also includes infrastructure, which has been neglected in recent years,” Esken said. “Too little has been invested in energy, network infrastructure, roads, railways, collapsing bridges, but also social infrastructure.”
Merz would also have to convince the Green party in order to secure a two-thirds majority. The Greens have pushed for a broader debt brake reform.
Caretaker chancellor Scholz, who led the SPD to its worst result since the turn of the 20th century, campaigned on relaxing the debt brake. But such a reform would take months and probably face stiff opposition from some factions in the CDU/CSU.
A way to temporarily circumvent the debt brake is to set up off-budget funds in the constitution. Scholz set up a €100bn vehicle in 2022 to buy military equipment and weapons following Russia’s full-scale invasion of Ukraine.
More than 80 per cent of this fund, which expires in 2027, has been committed, but one option is to top it up. The two-fund package would be a rapid “political compromise” to avoid a more complex debt brake overhaul, Steinbach said.
The proposal was drafted last week by experts from the country’s economic institutes.
The unsolicited proposal was brokered by Jakob von Weizsäcker, a former academic economist and SPD politician who is the finance minister of Saarland. The experts argued that the need to increase defence capabilities quickly was a strong argument for using debt, said two people with knowledge of their thinking.
They also endorsed an overhaul of the debt brake during the next legislature. But politicians needed to act quickly and at scale, they wrote. “There is no point in discussing €100bn or €200bn,” said one of the people.
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