German elections: the day after
After lingering uncertainty about which parties would reach the electoral threshold, the German elections on 23 February eventually produced an unambiguous result. The new coalition will most likely consist of the Christian Democratic CDU/CSU and the Social Democratic SPD, led by CDU leader Merz as the new Chancellor. Negotiations on the coalition agreement will be difficult and may take some time. Among other things, the parties have to find a compromise on migration policy and a solution to the federal government's budget impasse, which tripped up the previous government. On the latter, the most likely course seems to be the declaration of a budgetary emergency, which would temporarily suspend the constitutional debt brake. After all, other solutions would require a constitutional amendment for which the classical centrist parties do not have a two-thirds majority. On balance, the German election results allow for the quick formation of a centre coalition that avoids a political blockade by the AfD. Future Chancellor Merz stated that European cooperation in a rapidly changing geopolitical environment will be his top priority.
Early elections
Yesterday, 23 February, Germany elected a new Bundestag. Those early elections became necessary after the Liberals left the 'traffic light' coalition with the social democratic SPD and Greens in November 2024, causing the coalition to lose its parliamentary majority. Following a (planned) loss of a confidence vote in parliament in January 2025, early elections were programmed, which were originally only scheduled for September this year.
Even before the fall of the government, the internal stalemate in the coalition had been dragging on for quite some time. This led to a historically high level of uncertainty about (economic) policy (Figure 1):
The main cause of the premature end of the 'traffic light' coalition was fundamental disagreement on fiscal policy. Sorting this out will be one of the first and most important tasks of the new government coalition, of whatever composition.
A number of events put the budget discussion in the 'traffic light' coalition on edge. Shortly after the coalition took office in late 2021, Russia invaded Ukraine and subsequently the acute energy price crisis erupted. Both military support to Ukraine, and measures to address the energy crisis (including the replacement of Russian gas supplies) meant a significant additional budgetary burden.
Moreover, in 2023, the constitutional court quashed the improper reuse of unspent pandemic aid for climate purposes. This put the government's budget plans further in trouble. At the same time, the liberal FDP refused to solve this 'problem' by declaring a fiscal emergency, which would have meant that the federal budget would not have to adhere to the constitutional debt brake (a maximum deficit of 0.35% of GDP for the federal government) in that year. Since the SPD and Greens refused to fund the extra budgetary costs, resulting from the constitutional court's ruling, with savings in the current budget, Chancellor Scholz (SPD) sacked the Liberal finance minister. This led to the end of the 'traffic light' coalition and consequently early elections. Either way, this budgetary dilemma will not disappear and the next government will have to find a solution to it.
Vote count remained tight
The preliminary official results of the elections were in line with expectations. In the end, they were still tight because it was far from clear whether the liberal FDP and the new party Bündnis Sarah Wagenknecht (BSW) would reach the 5% electoral threshold. After all, this has a major impact on the distribution of seats and thus on the possible formation of a coalition. In the end, both parties did not reach that threshold.
As expected, the Christian Democratic CDU/CSU party became the largest (28.5% of the votes), followed by the AfD (20.8%), the Social Democratic SPD (16.4%), the Greens (11.6%) and Die Linke (8.8%). All other parties remained below the 5% electoral threshold, as mentioned above. Based on the resulting seat distribution, the only plausible government coalition consists of CDU/CSU and SPD, with CDU president Merz as chancellor. After all, all parties have ruled out a coalition with the AfD and the CDU/CSU is mathematically 'incontournable'. The classical centre parties (CDU/CSU, SPD and Greens) do not have a two-thirds majority in the new parliament, making any constitutional amendments to solve the budget dilemma very difficult, if not impossible.
Domestic policy probably more stable
Firstly, such a coalition between the CDU/CSU and SPD would mean a return to the stability of a two-party coalition (although strictly speaking, this coalition too consists of three parties since the CSU is an independent party). That was the norm in past decades. The 'traffic light' coalition was an exception to this. This contributed to political instability, since the chancellor's traditionally strong constitutional position shifted from 'head of government' to 'mediator' between three parties of largely the same electoral weight after the 2021 elections.
From a slightly longer perspective, a CDU/CSU-SPD coalition would be a continuation of the penultimate government in terms of composition, but obviously with new political personnel. The 'traffic light' coalition would literally have been an interlude in such a scenario. However, the reinstatement of the former coalition would not simply be a continuation of Merkel's policy. After all, the transition from Merkel to Merz is not just a mere personnel change. Especially on migration policy, the focus is likely to be different. On this issue in particular, negotiations with the SPD are likely to be relatively difficult.
Closer European cooperation
A coalition between the CDU/CSU and the SPD could lead to closer European cooperation. In concrete terms, this is likely to rely mainly on the so-called 'Weimar Triangle' (Germany, France and Poland). This is relevant in the context of recently rapidly rising geopolitical uncertainties. On Ukraine, while there is a broad consensus among future coalition partners to provide support, the SPD has so far been somewhat more fearful of escalation in this regard. The policy of a Chancellor Merz on this issue would probably be less reluctant, but he will have to find a compromise in the coalition with the SPD in this. In any case, Merz already announced that European cooperation on defence is an absolute priority for him.
Looser fiscal policy thanks to (temporary) quick fix
The main dilemma concerning economic-budgetary policy is the same one that ultimately brought down the 'traffic light' coalition. It relates to the increased pressure on the federal budget (for spending on defence, green transition, infrastructure investment, social security...) and the question of how to finance it. In principle, this could be done by either temporarily suspending the constitutional debt brake by declaring a budgetary 'state of emergency', weakening the constitutional debt brake, or by creating (new) debt vehicles in the constitution that fall outside the debt brake.
One of the main consequences of the election results is that the new coalition does not have a two-thirds majority, even with the support of the Greens. As a result, amending the constitution, either to weaken the debt brake or to write new financing vehicles into the constitution, is no longer a realistic option. Indeed, the party 'Die Linke' already indicated that higher defence spending is not negotiable. The CDU/CSU's sceptical but not dismissive stance on this has therefore become largely irrelevant.
Part of the solution may be a greater role for funding at the European level (EU together with possibly the UK), primarily for defence. Until further notice, however, the CDU/CSU remains reluctant to expand financing through common EU bonds.
The only realistic way out to solve the fiscal dilemma in the short term therefore seems to be for the new government to simply declare a fiscal 'state of emergency', thus temporarily suspending the debt brake. Given current geopolitical developments, this would be plausible. Moreover, the main advantage of this course of action would lie in the fact that the coalition can decide this without opposition support. In principle, that procedure could also be used in the next few years. The constitutionality of a quasi-permanent budgetary emergency, while not certain, is also not impossible given the current far-reaching geopolitical developments. Indeed, the constitutional court traditionally holds back when it comes to purely political assessments, which may include the need for higher defence spending. This budgetary procedure could buy time for the current and subsequent fiscal years. In any case, a structural solution will have to be found by 2028, when the existing constitutional budgetary vehicle (amounting to EUR 100 billion) for part of defence spending will be used up. Thus, based on current legislation, all defence spending will have to be financed from the current budget from 2028 onwards.
Cautious optimism
For now, we draw four main conclusions from the election results. First, a two-party coalition is likely to emerge again (if we take CDU/CSU together as a political family). That will probably allow for a more stable operation, with a more dominant role for the Chancellor. However, the necessary substantive compromise between the CDU/CSU on the one hand and the SPD on the other will be difficult. As a result, the new coalition may not be able to take office before Easter. The compromise mainly embraces domestic policy (the migration debate) and the structural way of financing the necessary public investments (defence, infrastructure and climate) in the coming years through a looser fiscal policy. Perhaps this will happen for the current fiscal year by declaring a financial emergency. That more expansive budget fits into our economic scenario of a gradual and moderate cyclical recovery in Germany from the second half of 2025.
Secondly, we note that the German election results allow a new centre coalition with a parliamentary majority to be formed relatively quickly. In this way, a blockade by the AfD is avoided.
On the other hand, thirdly, the classical centre parties (CDU/CSU, SPD, Greens) no longer have a two-thirds majority in parliament (the liberal FDP failed to meet the electoral threshold). This means that a structural and permanent solution to the debt brake issue is unrealisable until further notice. The legal vulnerability of declaring a "fiscal emergency" will be the budgetary Achilles heel of the new coalition.
Finally, the new coalition, with new political personnel, is likely to be good news for European cooperation, inside and outside the EU (more precisely with the UK). The next Chancellor Merz already indicated that such cooperation is a top priority for him, given the rapidly changing geopolitical environment.