November 25, 2025
The German Coalition Faces a Moment of Truth
Developments of the year and a well-founded outlook: Read our experts’ analyses and forecasts on economic policy here.
The 2026 Annual Outlook – Economic Policy
- Dr. Moritz Kraemer · Chief Economist and Head of Research
Expectations for the new German government were high – probably too high. After all, this coalition owes its very existence to the fact that it was the only viable option short of breaking the so-called "firewall" against cooperating with the far-right Alternative for Germany (AfD). The programmatic differences between the Christian Democrats (CDU/CSU) on one hand and the Social Democrats (SPD) on the other remain significant. These are not exactly the ideal conditions for ambitious reform policies. As a result, the much-trumpeted "Autumn of Reforms" has turned out to be little more than a few weeks of minor adjustments. For instance, the reconfiguration of Germany's basic income scheme amounts to little more than symbolism. Similarly, the tax-advantaged "active pension" starting in 2026 might result in opportunistic windfall effects but does nothing to address the core issues of the precarious finances of the public pension system.
Still, the most significant measure of Chancellor Friedrich Merz’s government was passed before it even took office: the weakening of the fiscal debt brake. But this was less a reform and more a complete dismantling. For someone like me, a steadfast advocate of reforming the debt brake, the constitutional amendment is nothing short of sobering. It opens up a sea of red ink. Federal budget deficits could balloon to around 4% of GDP by the end of the legislative term. At the same time, capacity constraints in the defense and construction sectors may result in less economic growth than hoped for, but in rising prices. In that case, a lot of money might be spent with little to show for it in terms of economic output.
Worryingly, there are growing signs of the feared "budgetary shell game": the government has begun shifting investments from the core federal budget to special funds, effectively creating more room in the primary budget for consumption expenditures. On top of that, costly electoral giveaways – totaling some €10 billion annually – are adding pressure, with measures like expanded mothers’ pensions, higher commuter tax allowances, reduced VAT for restaurants, and subsidies for agricultural diesel.
Let’s cross our fingers that all of this turns out to be nothing more than the teething troubles of a new coalition and that 2026 brings better governance. Right now, I am not betting the farm on it.
Germany's debt ratio is likely to grow significantly
Public debt as a percentage of GDP
Key questions from clients answered by our experts
The black-red coalition was not a love match. Will it survive the legislative period?
While coalition negotiations went relatively smoothly, day-to-day governing is facing some hurdles. That said, neither the Union nor the SPD are pushing for early elections, as neither of them are doing well in the polls. The parties will give their all to make this marriage of convenience work and hope that an economic upswing will soften the electorate’s mood.
Will the new basic income relieve some pressure on the federal budget?
Yes, albeit to a minor extent. The Chancellor's expectations of saving €5 billion (about 10%) are optimistic. The Federal Constitutional Court issued a clear ruling to ensure the minimum subsistence level. The most recent figures show that the number of non-compliant Bürgergeld (Citizens’ Benefit) recipients was well below 0.5 %. Notably, only some 4% of federal social assistance was spent on this Citizens’ Benefit.
Dr. Moritz Kraemer · Chief Economist and Head of Research
The 2026 Annual Outlook – eight topics in focus
The 2026 annual outlook – PDF download
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3.3 MB | 25.11.2025
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