At times this year, it seems as if the world is changing at breakneck speed. Understandings, practices and institutions built over decades are changing in days.
Germany provides a poignant case study on this front. The country is a leading member of the North Atlantic Treaty Organization (NATO) and the European Union (EU); Frankfurt is the headquarters of the European Central Bank. German economic policies, focused on fiscal discipline and inflation control, have been central to the compact binding euro area countries together.
Rapidly changing circumstances, however, have forced a re-evaluation of Germany’s core principles. With U.S. support for NATO wavering and a trade war brewing, the German government has proposed an amendment to its constitution to address growing challenges.
Germany has made generational change in just a few weeks.
Up until now, Germany has adhered to a debt “brake” which limits budget deficits to 0.35% of gross domestic product (GDP). By contrast, the United States is dealing with annual shortfalls of 6% of GDP; the average across Western Europe is over 4%. The lack of fiscal space has challenged Germany’s economy, which has gone from triumph to travail.
American foreign policy, however, has encouraged Europe to become more self-sufficient for their security. And reciprocal tariffs against the EU have been threatened for April 1. These developments prompted the German parliament to amend the national constitution.
If ratified, defense spending in excess of 1% of GDP will be exempt from annual deficit restrictions. An infrastructure fund of €500 billion will be created. German states will gain the ability to run modest budget deficits. Taken together, these measures will provide substantial stimulus: early estimates suggest that they could eventually add more than 1% to annual real growth.
The prospect of higher deficits led bond markets to add more than 40 basis points to long-term German yields. Still, German interest rates remain well below those in other countries. And the ratio of German debt to GDP is well below that seen elsewhere.
Observers have been suggesting for some time that Germany needed to stimulate its economy, which has been very sluggish. While the circumstances under which change is occurring may not be ideal, the economic outcomes will be positive for Germany…and for the rest of Europe.
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