Better times ahead? Analysing Germany’s new macroeconomic reforms
16 JUL, 2026
By Felipe Villarroel
Felipe Villarroel, Partner, Portfolio Manager, TwentyFour AM (a Vontobel boutique)
The German government has been quite active and bold since it took power around 15 months ago. Formed as a coalition between the Christian Democratic Union/Christian Social Union (CDU/CSU) and the Social Democratic Party (SPD), it began its term earlier than expected with a controversial loosening of the debt brake that allowed it to significantly increase defence spending – carried out via a vote in the "old" Parliament, just days before the new one took office. There have been ongoing disagreements between the coalition partners on certain issues, including taxes, pensions and others, while there has been unity in marginalising the far-right party Alternative for Germany (AfD) as much as possible. All of this is unfolding against a backdrop of growing pressure on the government, given that the German economy remains stagnant.
In early July, one of the most ambitious reform packages in recent times was presented. In marked contrast to the fiscal measures adopted in other G7 countries, we believe this is a solid set of measures that, at the very least, aims to address certain structural problems, rather than simply raising taxes blindly to fund unsustainable spending with little added value. As such, this is not necessarily a package that will deliver overnight results through higher consumption; instead, its impact is likely to be felt over time, as confidence grows that the economic outlook is starting to look more promising. It's worth noting that Germany is in an exceptional position, as it has ample fiscal room to increase its deficit, given that years of austerity have left it with debt-to-GDP ratios and budget deficits substantially better than those of other G7 countries.
The most significant structural measures involve a more flexible labour market, reduced bureaucracy and pension reforms. Germany has relatively high rates of sick leave compared to other developed countries. Planned changes in this area include eliminating the option of obtaining certain medical certificates by phone and requiring workers to see a doctor in person from the first day of illness. Other labour market measures include the possibility of extending fixed-term contracts up to six times (rather than three), more favourable tax treatment for severance pay if a new job is found relatively quickly, and eased rules for dismissing higher-salaried workers (those earning more than €177,000 a year).
On the bureaucracy front, the administrative burden on businesses will be reduced, and a "default approval" mechanism will be introduced for projects. This means that, for projects meeting the requirements, authorities will only have four months to effectively block them. If no action is taken within that period, the project will be considered approved.
Pensions are an area where the reforms are quite ambitious. The government has announced it will seek to implement the recommendations of the Pensions Commission, which include contributions from both employers and employees to a state pension fund – the so-called "funded pillar," inspired by the Swedish model. There will also be a slight increase in the retirement age linked to life expectancy starting in 2031, which will end the option of early retirement for certain workers with long careers, and self-employed workers will be required to contribute to the pension fund.
On the tax front, moderate tax relief will be introduced for middle-income households (by increasing the tax-free income deduction, lowering the threshold at which the 45% tax bracket applies, and introducing a maximum tax rate of 47% for the highest incomes).
We view these reforms as a positive step forward for the German economy. Although we would have preferred no increases in income tax, the rest of the package should generate stronger growth over time. It is not only these specific reforms that have inspired our confidence in the direction of German fiscal policy, but rather the overall trajectory since the current government took power. Moreover, the measures aim to address several structural problems that limit growth potential, such as rigid labour markets and excessive bureaucracy. These proposals are expected to become law in the second half of the year, pointing to better times ahead for the German economy.
