Germany: reform momentum building?

Now this optimism needs to translate into policy action. Following mixed results in regional elections and ahead of challenging votes in eastern Germany in the autumn, the coalition has framed the coming months as a “reform window”. Finance minister and SPD co‑leader Lars Klingbeil’s proposals on 24 March marked its opening salvo: these included rolling back early‑retirement pathways, adjusting marriage‑based income splitting, and ending free public health insurance for non‑working spouses. These measures, aimed at expanding labour supply and improving incentives, signal a willingness to tackle politically sensitive issues. If backed by further reforms that encourage work and create jobs during the 2027 budget talks, running until July this year, this could become the biggest reform push in over 20 years.

The overall direction of travel is encouraging. Germany’s long‑term drift – declining competitiveness, high energy prices, and geopolitical vulnerabilities – requires urgent action. With fresh fiscal space and bipartisan recognition of the need for renewal, there is a plausible path back to stronger growth and higher investment.

Still, several qualifications are warranted – not to undermine the optimistic case, but to give it firmer footing.

1. The demand impulse helps – but supply‑side follow‑through matters

The recent boost to confidence and domestic demand was an essential first step. Yet the short‑term uplift remains sensitive to external shocks, as the Iran‑related uncertainty illustrates. And while the fiscal package has strong cyclical value, much of it is not yet feeding into productivity‑enhancing infrastructure – the area where Germany needs the biggest lift.

This does not negate the positive impact. Rather, it highlights the importance of execution. If the fiscal impulse is paired with streamlined and accelerated project rollout, the current momentum could translate into a durable improvement in Germany’s potential growth rate.

2. Fiscal sustainability concerns are manageable – but should not be ignored

Markets have so far reacted constructively to the fiscal expansion, and with good reason: Germany is entering this phase with low starting debt, strong institutions, and deep capital‑market trust. Swap-spreads have remained largely stable, suggesting markets can digest the rising bond supply. That said, Germany’s debt ratio will rise. Our models suggest that on current nominal growth and interest rate trends, Germany’s debt ratio could surpass Spain’s in the middle of the next decade (see Exhibit 2).

This does not imply acute fiscal risk. But showing a credible medium term plan will help maintain favourable funding conditions and support confidence that government policies can boost growth without triggering excessive inflation. The bar is not high: moderate consolidation once growth normalises and clearer prioritisation of infrastructure spending would be sufficient.

3. A domestic demand‑driven model is viable – but only with investment tailwinds

Germany’s pivot toward stronger domestic demand is strategically sound. It strengthens resilience to external shocks, reduces reliance on global supply chains, and creates a more balanced growth profile. But domestic demand requires several reinforcing pillars: rising labour supply, targeted public investment, and renewed private‑sector confidence in Germany as a production location.

None of these is out of reach. Participation rates for women and older workers are already high (see Exhibit 3), but the prevalence of part‑time posts suggests further gains are possible. Germany remains a global manufacturing centre with strong human capital. And if infrastructure spending accelerates, energy costs stabilise, and geopolitical uncertainties fade, the investment climate could improve more quickly than skeptics assume.

The demographic headwinds are real – but they are a known challenge and can be mitigated through immigration, upskilling, and reforms of the labour market. None of these undermines the broad reform narrative.

4. Political execution risks – last chance for the centre?

Structural reforms inevitably generate short‑term discomfort. The coalition will need to balance political sensitivities with economic necessity. Yet the fact that previously taboo issues – early retirement, tax privileges, labour‑market rigidities – are now openly discussed is itself a sign of political maturation rather than fragility.

Germany’s economic stagnation since 2018 has undoubtedly helped erode voter support for the traditional pro-EU mainstream parties. Tough reforms may be the centrists’ last chance to not just turn around the economy, but also their own electoral prospects.  However, the riskiness of the approach should not be underestimated. Unpopular reforms can cost votes and further loosen the centre’s grip on power, with implications for the rest of Europe as well.