For a central bank that over past decades built a steely reputation for rejecting policies deemed as inflationary or destabilising, Germany’s Bundesbank is starting to gain significant practice in saying ‘yes’ rather than ‘no’.
The Bundesbank published on 4 March the culmination of work over several months on reforming Germany’s constitutionally enshrined ‘debt brake’. This coincided with a far-reaching decision on relaxing borrowing rules by the parties likely to form the next Berlin government – paving the way for several hundred billions of euros of investment for defence and infrastructure in coming years.
Prospective Chancellor Friedrich Merz, leader of the Christian Democratic Union, which won the 23 February general election, unveiled a plan for massive fiscal stimulus to counter the twin threats of economic stagnation at home and military confrontation on Europe’s eastern borders.
The political proposals are a necessary compromise to secure agreement from the CDU’s likely coalition partners, the Social Democratic Party (SPD) of outgoing Chancellor Olaf Scholz. Yet they spell possible problems for Merz within his own centre-Right constituency.
By abandoning his previous commitment to fiscal rectitude, Merz will win plaudits from heavily indebted European countries such as France and Italy – as well as from US President Donald Trump. But, still over a month away from potentially forming a government, Merz risks alienating members of his own party worried about a lurch towards more debt and fewer fiscal reforms promised before the elections.
The Bundesbank’s debt brake concept, envisaging additional investment of up to €220bn in the years to 2030, has been leapfrogged by the future government’s still more substantial plan.
The Bundesbank’s reform proposals are centred on the 60% reference value for debt to gross domestic product enshrined in the European Union treaties. Although more conservative than the plans announced on the same day by Merz and other party leaders in Berlin, the Bundesbank’s recommendations provide valuable accompanying support for the politicians’ proposals.
Nagel following more activist agenda
Joachim Nagel, Bundesbank president since January 2022, has followed a more activist agenda than his predecessor Jens Weidmann in areas like digital currency development, climate change and capital markets union. The Bundesbank’s legal framework within the Eurosystem empowers it to act as adviser to the government on ‘monetary policy issues of major importance’. However, Nagel is testing what might be considered a de facto enlargement of the bank’s responsibilities beyond its core mandate geared to price stability.
The government plan, agreed with the CDU’s Bavarian sister party, the Christian Social Union, as well as the SPD, is due to go before the Bundestag next week. It goes considerably further than the Bundesbank proposal, exempting defence spending above 1% of GDP from the debt brake, theoretically allowing unlimited debt for reequipping the armed forces and providing military assistance to Ukraine.
Moreover, the future coalition partners will introduce another constitutional amendment to establish a special €500bn infrastructure fund over 10 years, as well as providing more leeway for borrowing by the German states or Länder.
The fast-track action is virtually unprecedented in a country that takes its time over coalition-building. It has been forced by Trump’s aggressive withdrawal of support for Ukraine in its war with Russia, as well by the need for special measures to change legislation embedded into Germany’s Basic Law or constitution.
Merz pledges ‘whatever it takes’ to support ‘freedom and peace’
Merz said on 4 March Germany would do ‘whatever it takes’ to support ‘freedom and peace’. This was a conscious attempt to summon resonance equivalent to the celebrated euro-buttressing phrase coined in 2012 by Mario Draghi, then president of the European Central Bank.
Merz stressed the linkages between the twin components of the package, saying additional spending on defence could be accomplished only if ‘our economy returns to stable growth within a very short period of time’. This made necessary ‘rapid and sustainable investments in our infrastructure’.
The likely coalition partners, requiring a two-thirds majority in the Bundestag for constitutional changes, are constrained to enact their plans under the current legislative period, which ends on 24 March. In the future parliament, elected on 23 February, but not yet convened, the far-Right Alternative for Germany (AfD) and radical Left Die Linke together will hold a blocking one-third minority of seats as a result of the fragmentation of the political centre-ground in last month’s election.
Reflecting the need for urgency, the debt measures are likely to be passed with the support of the Greens and liberal Free Democrats, the two parties together with the SPD in the ill-starred ‘traffic light’ coalition that collapsed in November. The Greens look set to demand concessions on environmental and climate mitigation policies as conditions for approval.
Landmark speech on climate change
Nagel further strengthened his reputation for economic activism in a landmark speech on climate change co-organised by OMFIF at the Adam Smith Business School at Glasgow university last month. He backed European capital markets union as a key mechanism for mobilising necessary investment – aiming to bring in private capital through blended finance structures.
He outlined how Germany could become a pioneer in blended finance solutions, providing valuable insights for structuring climate investments at scale. Innovative structures already established at state financing agency KfW – where Nagel was a board member in 2017-20 during a break from his central banking career – could act as an ‘ice breaker’ for European climate financing solutions, he suggested.
He said investors often hesitate to take on risky projects, necessitating innovative financing tools where high-risk components are covered by public funds, ensuring sustainable private sector participation. However, there is a need to prevent a ‘race to the bottom’ in financial standards. Private investors must navigate short- and long-term financial considerations when allocating capital to transition finance. Political uncertainty and a lack of clear long-term policies can deter investment, leading to inaction, Nagel said. Stability in regulatory frameworks is essential for encouraging private sector participation.
Nagel said that additional financing needs are likely to be much lower than the estimated additional investment needs to achieve the EU’s climate goals as defined by the European Commission’s accounting perspective. He explained that this is because not all investments needed economic resources and financing beyond what the economy spends to maintain its capital stock. ‘In many cases, we are replacing fossil fuel-based technologies with greenhouse gas-neutral alternatives. And this requires additional financing only if greenhouse gas-neutral technologies are more expensive or if the capital stock being replaced is not yet fully depreciated.’
Citing a recent study, Nagel said that Germany would have to invest around €390bn annually from 2021 to 2030 to reduce emissions by 55% compared to 1990. However, only around 30% of this investment requires additional financing. In absolute terms, this amounted to a more manageable figure of about €120bn.
David Marsh is Chairman and Emma McGarthy is Head of the Sustainable Policy Institute, OMFIF.
Read a more detailed summary of Nagel’s speech here. Read the full speech here.
Interested in this topic? Subscribe to OMFIF’s newsletter for more.