Before Friedrich Merz won Germany’s parliamentary elections in February of this year, the country faced a money dilemma: Germany’s economic stagnation required significant reform and investment to revitalize industry, and the United States demanded more spending on collective defense. The budgetary dispute over how to simultaneously address these conflicting priorities had led to the collapse of Chancellor Olaf Scholz’s government. To avoid the same fate, lawmakers in Merz’s grand coalition, comprising the center-right Christian Democratic Union and the center-left Social Democratic Party, as well as the Greens, agreed to leverage debt to finance its dual obligations. Suddenly, Germany was flush with money. 

Seven months in, however, Merz’s government has still been unable to chart a course for economic reform and persuade voters that better days lie ahead. Merz’s bold moves on defense spending have confirmed Germany’s leadership role in Europe but at a cost to his domestic popularity. Merz’s expenditure of significant political capital at international summits to manage U.S. President Donald Trump and defend Ukraine has left him vulnerable to accusations that he is focusing too much on foreign policy and not enough on domestic issues. The right-wing, Russia-friendly Alternative for Germany party (AfD) is channeling economic anxiety to profit in the polls, criticizing Merz’s government for squandering German wealth to build a “war economy.” And although Merz’s efforts on defense have won him praise from the White House, the Trump administration is steadily undermining him by normalizing the AfD and—in the words of the newly released National Security Strategy—other “patriotic European parties.”

Merz’s government does not have much time to hedge against growing discontent within the electorate. Failing to pursue reforms to revitalize and grow Germany’s economy could jeopardize public support for Merz’s centrist coalition. If the Christian Democrats and the Social Democrats cede more ground to the AfD, they may also lose their ability to build viable future coalitions. If the grand coalition proves unable to pursue a path of economic reform and growth, it could break up the government prematurely and reverse Germany’s long-awaited leadership role in Europe, to the detriment of U.S. interests.

Angela Merkel, Germany’s former leader and Merz’s chief rival, became chancellor in 2005 by sidelining Merz and other candidates. She then managed to stay in power for 16 years by avoiding potentially disruptive reforms. This is not a formula that Merz can afford to follow.

Merz entered office with a mandate to build up Germany’s defense capabilities and improve its economy. To avoid the guns-versus-butter debate haunting many European governments, Merz bucked his party’s traditional preference for fiscal discipline and pushed the parliament to loosen Germany’s debt brake. Established in 2009, the brake caps deficit spending at 0.35 percent of GDP. Soon after this year’s federal election, the German parliament amended the debt brake to allow for unlimited deficit spending on defense and avoid significant cuts in areas such as social welfare. Merz also agreed to earmark an unprecedented 500 billion euros to invest in Germany’s crumbling infrastructure.

At the same time, Berlin has sought to fulfill the country’s obligations to European security. During........

© Foreign Affairs