The German Economy Confronts the Shock of the Century

An Extraordinary Plan

2025 won't be remembered as a year of breakthroughs, but rather as one of slow recovery. According to Florent Wabont (Ecofi), German growth is expected to range between 0% and 0.5%, following two consecutive years of economic decline.

The Eurozone's largest economy has faced numerous shocks: the energy cost surge after Russia's invasion of Ukraine, the contraction of the Chinese economy—a crucial market for its industry—and the rapid increase in interest rates in Europe.

As a result, the German model, based on cheap energy and high-value exportations, has simultaneously faced internal and external pressures.

At the beginning of the year, Friedrich Merz's election as chancellor marked a significant political turning point. His government introduced an economic modernization plan of a scale unmatched since reunification.

The unveiled program includes several extensive components. First, a 500-billion-euro plan, roughly 11% of GDP, aimed at modernizing German infrastructure, primarily to support the ecological transition. The effort is planned over twelve years to stabilize public investment over time.

Simultaneously, Germany is altering a key constitutional pillar: the debt brake mechanism will no longer apply to military spending exceeding 1% of GDP. The goal is clear: to increase military spending from about 2% of GDP in 2024 to 3.5% in 2029.

This marks a significant paradigm shift for a country long opposed to defense spending.

Add to these announcements a reduction in corporate taxes and an almost 14% increase in the minimum wage spread over two years.

But the main question remains: can this package truly get the economy back on track?

The Core Debate: The Budget Multiplier

As Ecofi points out, the effectiveness of this plan depends on the fiscal multiplier, meaning the ability of one euro spent by the government to generate more than one euro of GDP.

There is no academic consensus regarding defense spending: estimates vary widely, and initial conditions play a crucial role. However, Wabont favors the hypothesis of a multiplier greater than 1, at least in the initial years of the program.

Several factors support this view:

1. Intra-European reactivation of the defense industry.
Documents obtained by Politico indicate that most arms purchases will be directed towards European suppliers. This limits imports and enhances the domestic effect.

2. Sectoral boost through infrastructure.
The modernization of transport, energy, or digital networks could benefit many neighboring countries and mobilize the European industry, amplifying the regional multiplier effect.

3. High productivity potential.
Investments in R&D, AI, new industrial processes, and energy efficiency are expected to support productivity in the medium term.

4. Potential imitation by other European countries.
Although the probability is low in the short term due to budgetary constraints, the German example could inspire other economies, increasing European coherence in long-term investments.

Finally, Germany currently has underutilized industrial capacity: according to the IFO survey in October, the manufacturing industry is operating at only 78.2% of its capacity, compared to a historical average of around 85%. This indicates that supply can absorb a rapid increase in public demand without immediately creating massive inflationary pressures.

The Key Role of the ECB

The main challenge will also lie in the reaction of the ECB. Ecofi is currently anticipating a monetary status quo until the first half of 2026, allowing the German plan to produce its initial effects. However, a slight tightening is possible in the second half of the year if inflationary pressures intensify, with a mechanical risk: the rise in credit costs could slow the recovery.

Further tensions might arise from the labor market, already stressed by demographic pressures. Without an increase in immigration or employment rates, some sectors could face bottlenecks.

There are also internal political hurdles. The plan depends on coordination between the federal government and the Länder, each with its own budgetary constraints.

Some criticisms have already emerged: a group of German economists believes that the funds could be partially used to finance current expenditures instead of investments, reducing the real impact on the economy.

This massive stimulus also carries a symbolic dimension: according to Ecofi, it aligns directly with the Draghi report submitted in September 2024, which called for reconciling security, strategic autonomy, and decarbonization. It is an ambitious European project but still far from coordinated implementation.

Is the European Cycle Heading for a Recovery?

The stakes go far beyond Germany.

If the fiscal multiplier proves to be high, the German stimulus could lead the eurozone into a more dynamic cycle after several years of sluggish growth.

The European Central Bank has already begun reducing its rates since 2024, but these decisions have not yet fully permeated the economy. The drop in inflation has restored purchasing power and could continue to support demand in 2026.

Admittedly, disappointments remain possible. However, for Ecofi, the Merz plan is a welcome boost, likely to arrive at the most decisive moment of the cycle. The most cyclical sectors (construction, manufacturing) are already beginning to show signs of improvement.

If this restart is confirmed, it could mark a significant milestone for the eurozone: the return of industrial policy, substantial investment, and rearmament that will durably redefine the European balance.