Funding defense spending again from the core budget in the medium term – which would be equivalent to spending cuts or tax increases – the central bank suggests (Βundesbank) of Germanyin order to avoid the public debt soaring even above 100% of its GDP.
Investments in Germany should also be financed from the regular budget, according to the Bundesbank. The Bundesbank explicitly proposes “the increasing financing of defense costs within the framework of the regular budget either through higher revenues or through the abolition of certain costs”!. In return, the Bundesbank wants to raise the allowed debt ceiling for the state by up to 1.5% per year.
The Bundesbank considers further reform of the debt brake important and has presented a contribution to the debate. This input is based on the Bundesbank’s reform proposals from early 2025 and takes into account the new underlying situation resulting from the reform of fiscal rules in March 2025. The reformed German fiscal rules allow for large deficits. Under these rules, the debt ratio could rise to nearly 90% by 2040 and even exceed 100% in the long term. The recommendations now presented by the Bundesbank for a future reform of the debt brake aim to stop this upward trend in the medium term and stabilize the debt ratio back to 60% in the future.
The Bundesbank’s recommendations represent a consistent overall package that ensures effective fiscal policy and sound public finances. The package establishes a framework for systematic and stable fiscal policy. At the same time, it safeguards reliably sound public finances and takes into account EU fiscal rules. During the transition phase, the amount of defense spending financed by borrowing is gradually reduced. Thus, the fiscal margin turns more and more towards investment. In the target zone, the fiscal margin for investment is stabilized. The proposal is therefore a continuation of the Infrastructure and Climate Neutrality Fund and better protection of investments with credible prospects.
Germany’s fiscal rules were overhauled in March 2025. Extensive borrowing room was created to address the main challenges in the defense and infrastructure sectors. This is appropriate on a temporary basis.
However, in the Bundesbank’s view, persistently high deficits come with significant risks and side effects: a sharply rising debt ratio limits fiscal space in the future and public finances gradually lose their resilience. The government might then be less supportive of households and businesses in times of crisis and there would be a risk of conflicts with a stability-oriented monetary policy.
It is therefore important to have fiscal rules that ensure sound public finances and compliance with European fiscal rules in the long term. From the perspective of the Bundesbank, fiscal rules can be designed to better protect public investment in the future. In addition, fiscal rules should allow fiscal policy to be as stable as possible.
Reform in three stages
The Bundesbank recommends that fiscal policy and the “debt brake” be geared towards current challenges and sound public finances in a targeted and planned manner in three stages:
In the initial phase, it would be possible to run large deficits under existing borrowing ceilings. Bundesbank experts recommend, however, that lending be focused on the immediate additional needs for defense and infrastructure. This phase could be extended until 2029. If the borrowing margins are used in a targeted way, it seems likely that the general government deficit will increase to around 4% of GDP.
In a transition phase to follow, deficits will be gradually reduced, as required by EU fiscal rules, in order to restore a sound fiscal position. To this end, defense spending will be financed gradually to a decreasing extent from borrowing and to an increasing extent from current revenues. The Infrastructure and Climate Neutrality Fund will be able to continue to finance expenditure of almost 1% of GDP through borrowing. This phase could last from 2030 to 2035. During this phase, the general government deficit will be reduced to 1% of GDP.
In the target zone, a reformed debt brake would ensure sound public finances. At the same time, it would stabilize the borrowing margin for investment after the end of the Infrastructure and Climate Neutrality Fund. This target zone is largely in line with the reform proposals presented by the Bundesbank in early 2025. It would encourage investment and create guardrails for stability-oriented fiscal policy. In addition to authorizing borrowing for additional investment of 0.8% of…GDP, the proposal includes a margin for unspecified central and state government borrowing: if the debt ratio is above 60%, they are each given a structural margin to borrow 0.1% of GDP. If the debt ratio is below 60%, they can borrow 0.35% of each. Other aspects of the reform proposals facilitate, inter alia, the pursuit of a sound fiscal policy.