OECD Economic Outlook, Volume 2025 Issue 2

Germany

The economy is projected to grow by 0.3% in 2025, 1% in 2026 and 1.5% in 2027 (GDP with working day adjustments). Private consumption will increase due to low inflation, rising nominal wages and decreasing domestic policy uncertainty. High trade policy uncertainty and US tariffs will hamper investment in export‑oriented manufacturing and foreign demand. Private investment will pick up, supported by high corporate savings, declining interest rates and lower domestic policy uncertainty. Public spending on defence and infrastructure will rise strongly due to the increased flexibility in the fiscal rules and large investment needs.

Ensuring medium-term fiscal sustainability requires improved public spending efficiency, reallocation of spending and broadening the tax base, and addressing rising spending pressures due to rapid population ageing. Continuing to reduce administrative burdens, 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 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 stagnated in the third quarter of 2025. Exports decreased compared to the second quarter, while private investments in machinery and equipment increased. Energy prices remain higher than before the onset of war in Ukraine, particularly affecting output in energy-intensive industries. Monthly industrial production decreased in August, due to declines in automotive, machinery and equipment and pharmaceuticals output, and only partly recovered in September. Despite rising real wages, 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, domestic policy uncertainty has declined. The ifo business expectations indicator has increased since March, despite higher trade policy uncertainty. In September, retail sale volumes stood at 0.2% above the previous year’s level. Annual headline inflation eased to 2.3% in October. Core inflation remains sticky, at 2.8% in October, mainly driven by rising service price inflation, fuelled by strongly rising nominal wages. Although labour markets have cooled, unemployment remains low.

Rising trade protection and increasing competition from China in key export markets have weighed on export volumes. The rise in uncertainty about future US trade policy led to front-loading and a strong increase of exports in the first quarter of 2025, with export volumes remaining at that level in the second quarter despite a strong decline in nominal exports to the United States. Export values increased by 1.4% in September and stood 2% above the previous year’s level, but export volumes have started to decline.

Germany 1

Source: Federal Statistical Office; 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

After tightening by 0.4% of GDP in 2025, the fiscal stance will strongly expand by 0.5% of GDP in 2026 and 0.9% of GDP in 2027. Due to the fall of the previous coalition government and failure to conclude negotiations on the 2025 budget, a provisional budget restricted public spending until early October, when the 2025 budget and spending plans for special funds were approved by the new federal government. A reform of the national fiscal rules in March allows higher investments in defence and infrastructure over the coming years. The government plans to increase defence spending from 2.1% in 2024 to 3.5% of GDP by 2029, which will be financed by issuing public debt. Moreover, a debt-financed special infrastructure fund will provide up to about 12% of GDP for additional investment in infrastructure and the green transition over the next 12 years. As infrastructure planning and approval procedures will take time, public investment is expected to increase gradually from 3.1% of GDP in 2025 to 3.5% in 2027. Together with the existing climate and transformation fund, the new infrastructure fund will also finance support measures to crowd in private investment and accelerate the green transition.

Other measures are planned to revive the stagnating economy, modernise the public administration and address skilled labour shortages. Depreciation allowances for investment in equipment will be raised starting from 2026. It is also planned to reduce the electricity tax and network charges and raise subsidies for energy-intensive firms. The government has committed to reducing administrative burdens and accelerating the digitalisation of the public administration, including for example the establishment of a one-stop shop for setting up a firm. Moreover, labour supply incentives are to be raised by partially exempting from income taxes additional income from working extra-hours and earnings of workers above the statutory retirement age.

The recovery will be driven by domestic demand

GDP will grow by 0.3% in 2025, 1% in 2026 and 1.5% in 2027 (0.2%, 1.3% and 1.6%, respectively, without working day adjustments). Lower domestic policy uncertainty will support private domestic demand, with private consumption also helped by low inflation and rising nominal wages. Private investment will pick up due to high corporate savings, declining interest rates, tax incentives for equipment investments and measures to support firms during the green transition. However, high trade policy uncertainty and US tariffs will hamper investment in export-oriented manufacturing and weigh on foreign demand. Public investment in defence and infrastructure will rise strongly due to the increased flexibility in the fiscal rules and large investment needs, with potential for crowding in private investment. Headline and core inflation will start to rise in 2026 due to strongly increasing domestic demand.

A further escalation in trade policy tensions would weigh on GDP, as the manufacturing sector is strongly integrated in global supply chains. If public procurement and infrastructure planning and approval procedures are not accelerated, the implementation of public investment and other spending projects would be delayed, reducing GDP growth in 2026 and 2027. Moreover, if structural reforms to support the supply side of the economy are not implemented, the significant fiscal easing may lead to strongly rising inflationary pressures.

Structural reforms should complement the reform of fiscal rules

To ensure a quick and efficient implementation of public investment and defence spending, it is key to simplify and harmonise public procurement and infrastructure planning and approval procedures. This should be combined with improvements to public administration capacity, particularly at the local level. To avoid rising inflationary pressures, the reform of fiscal rules should be combined 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 digitalisation in 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, particularly in the construction sector, 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 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 through increased support for completion of formal VET degrees.