OECD Economic Outlook, Volume 2025 Issue 1

Germany

The economy is projected to grow by 0.4% in 2025 and 1.2% in 2026. Private consumption will increase due to low inflation, rising nominal wages and decreasing domestic policy uncertainty following the formation of a new government. High trade policy uncertainty will hamper investment in export-oriented manufacturing but, overall, private investment will pick up, supported by high corporate savings, declining interest rates and lower domestic policy uncertainty. Public investment in defence and infrastructure will rise strongly due to the increased flexibility in the fiscal rules and large investment needs. Rising US tariffs will weigh on foreign demand.

Ensuring medium-term fiscal sustainability requires improved public spending efficiency, reallocation of spending and broadening the tax base, while addressing rising spending pressures due to rapid population ageing. Continuing to reduce the administrative burden, digitalise the public administration and improve infrastructure implementation capacity, particularly at the municipal level, is needed to support the pick-up in public and private investment. To avoid rising inflationary pressures due to the significant demand shock from fiscal easing, it is key to reduce barriers to firm entry and growth and address skilled labour shortages.

Weak external demand and high uncertainty have weighed on economic activity

Real GDP increased by 1.7% at a seasonally adjusted annual rate (saar) in the first quarter of 2025, mainly driven by private consumption and investment. Energy prices remain higher than before the war in Ukraine, particularly affecting output in energy-intensive industries. Monthly manufacturing production increased by 3% in March and was 0.2% below the level a year earlier. Despite an increase of real wages by 3.1% in 2024, the recovery of private consumption has been slow due to high domestic policy uncertainty. However, since the federal elections in February and a reform of the fiscal rules in March, policy uncertainty has declined. The ifo business expectations indicator has increased since March, despite higher trade policy uncertainty. Retail sale volumes decreased in March by 0.2% but stood 2.2% above the previous year’s level. Annual headline inflation declined to 2.2 % in April from 2.3% in March, mainly driven by declining energy prices. However, core inflation remains sticky, at 3.1% in April, due to strong services price inflation of 4.5% driven by strong nominal wage gains. Although labour markets have cooled, they remain robust with low unemployment and high vacancies still signalling strong labour shortages.

Rising trade protection and increasing competition from China in key export markets have weighed on export volumes, which strongly declined in the second half of 2024. However, in March 2025, nominal exports were 2.3% above the level observed one year earlier, helped by rising export prices and a structural shift in manufacturing towards higher value-added products. The recent rise in uncertainty about future US trade policy also led to a front-loading of exports in the first quarter of 2025. Higher US tariffs will strongly affect manufacturing firms as about 10% of total goods exports are shipped to the United States.

Germany 1

Source: Federal Statistical Office; Bundesbank; ifo business surveys; and GfK.

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Germany: Demand, output and prices

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Germany 2

1. Harmonised index of consumer prices.

2. Harmonised index of consumer prices excluding food, energy, alcohol and tobacco.

Source: Federal Statistical Office; and Eurostat.

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Defence spending and infrastructure investment are set to increase strongly

The fiscal stance will tighten by 0.3% of GDP in 2025 and expand by 0.9% of GDP in 2026. Due to the fall of the previous coalition government and failure to conclude negotiations on the 2025 budget, a provisional budget for 2025 extends nominal spending levels from 2024 to 2025. However, a recent reform of the national fiscal rules will allow for raising investments in defence and infrastructure in the next few years. Additional spending exceeding 1% of GDP in the areas of defence, civil protection, intelligence services, protection of IT systems, and support for states attacked in violation of international law will be exempted from the fiscal rules. A special infrastructure fund will provide up to EUR 500 bn or about 12% of GDP for additional investment in infrastructure and the green transformation over the next 12 years. Moreover, the structural deficit ceiling for sub-national governments will be raised from 0% to 0.35% of GDP, and EUR 100 billion from the new infrastructure fund will be allocated to fund local public investment. The effects of this reform on public investment are expected to start materialising only in 2026 as the approval of the 2025 and 2026 budget and detailed investment plans as well as infrastructure planning and procurement procedures will take time.

Negotiations to form a new coalition government have been successful. The policy plans laid out in the coalition treaty emphasise the need to strengthen defence and internal security, address the large infrastructure backlog, revive the stagnating economy, modernise and digitalise the public administration, and address skilled labour shortages. It is planned to raise depreciation allowances for equipment investment, reduce the electricity tax and network charges, raise subsidies for energy-intensive firms, and support the car industry by increasing subsidies for electric vehicles and the commuter allowance. Labour supply incentives are planned to be raised by exempting additional income from working extra-hours, wage premia if switching from part-time to full time work, and earnings of workers above the statutory retirement age from labour taxes.

The recovery will be driven by domestic demand

GDP will grow by 0.4% in 2025 and 1.2% in 2026. Private consumption will increase due to low inflation, rising nominal wages and declining domestic policy uncertainty. High trade policy uncertainty will hamper investment in export-oriented manufacturing but, overall, private investment will pick up, supported by high corporate savings, declining interest rates and decreasing domestic policy uncertainty, including on the financing of measures to support firms during the green transition. Public investment in defence and infrastructure will rise strongly due to the increased flexibility in the fiscal rules and large investment needs. Rising US tariffs will weigh on export demand. Headline inflation will converge towards 2% in 2026, but core inflation will be sticky, reflecting the impact of wage gains amidst skilled labour shortages and rising public investment and domestic demand.

A further escalation in trade policy tensions would weigh on GDP, as the manufacturing sector is strongly integrated in global supply chains and the United States is the main export market. If public procurement and infrastructure planning and approval procedures are not accelerated, the implementation of public investment projects will be delayed, reducing GDP growth in 2026. Moreover, if structural reforms to support the supply side of the economy are not implemented, the significant demand shock from increased public investment may lead to strongly rising inflationary pressures.

Structural reforms should complement the reform of fiscal rules

Further simplification and harmonisation of public procurement, infrastructure planning and approval procedures should be combined with improvements to the capacity of public administration, particularly at the local level. This will ensure a quick and efficient implementation of public investment projects. To avoid rising inflationary pressures, it is key to combine the reform of the fiscal rules with structural reforms. Reducing high administrative burdens and regulatory barriers to entry and growth of firms, particularly in construction and services, is key to strengthen competition and revive business dynamism, investment and innovation. This will require accelerating the digitalization of the public administration, including by setting mandatory common IT standards, and expanding efforts to review, simplify and harmonise existing regulations and administrative procedures across levels of government. Occupational entry regulations and licensing requirements to open a business should be reduced to strengthen competition. Shifting the tax burden away from labour towards capital income and wealth, for example by reducing inheritance tax exemptions for business assets, would help improve labour supply incentives. Reducing fiscal incentives for early retirement would improve work incentives for older workers and help to stabilise pension spending amidst rising fiscal pressures due to ageing. To address skilled labour shortages, it is key to expand training opportunities for workers and the unemployed, including support for completing formal VET degrees.