What are the macroeconomic implications of the European defense shift?

On March 4, 2025, the European Commission launched the " ReArm Europe " initiative, an ambitious plan aimed at mobilizing approximately €800 bn to build a safe and resilient Europe. The project i nclude s several part s that could genera te a substantial budgetary leeway, estimated at €650 bn over four years. At the same time , a new loan instrument of €150 bn would be creat ed to support investments in strategic areas such as air defense and cybersecurity. Is Germany experiencing a paradigm shift in public spending? The future German Chancellor, F. Merz, announced on March 4 a legislative package aimed at significantly increasing defense spending (including the exemption from the debt brake for all defense expenditures exceeding 1% of GDP) and investing heavily in infrastructure (€500 bn over 10 years). A n early estimate of these measures – which will be detailed in a forthcoming publication – suggests an increase in the German deficit of around 1 p . p this year, and between 2 and 2.5 p .p in 2026 and 2027, depending on how the funds will be used (see also Paradigm shift in European defence for our outlook on interest rates). Several options exist to finance an additional effort in support of defense : i ) national borrowing, with l eeway for many countries, except for Germany; ii) borrowing from existing European institutions such as the ESM or the EIB; iii) engaging supranational instruments, either by reorienting existing programs or by launching a new issuance program. The second option is less likely , as it requires unanimous approval from the EU Council, endorsement from the European Parliament, and ratification by all national parliaments.