The EU Great Pivot

The road towards a fiscal union

We are witnessing a historic rebalancing of the world economic order. After decades of globalization and dependence on a unipolar financial system centered on the United States, regional economic blocs are now pursuing increasingly independent strategies.

Yesterday, we looked at the U.S. response to this shift. Today, we turn to Europe.

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From Austerity to Sovereign Demand

Europe, and especially Germany, built its post-2008 model around export surpluses and fiscal discipline. Domestic demand was intentionally suppressed via fiscal restraint, limited access to credit, and a growth strategy that relied heavily on external demand. That model is now collapsing under the weight of geopolitics, energy shocks, and the breakdown of global trade. In response, Europe is shifting its economic strategy, moving toward sovereign fiscal expansion, especially in defense and infrastructure.

Germany, once the symbol of balanced budgets, is leading this reversal. A constitutional amendment now exempts defense and infrastructure spending from its "debt brake," unlocking hundreds of billions in new public investment. Across the continent, governments are preparing for sustained deficits well above the old 3% ceiling, with the EU authorizing fiscal exemptions of up to 1.5% of GDP annually for defense alone.

This is not a temporary adjustment. It marks a structural shift. The EU has effectively moved beyond its Maastricht-era rules in favor of a domestically anchored growth model. The bloc is no longer relying on global capital flows or export-led surpluses. Instead, it is responding, whether explicitly or not, to the call made by U.S. Treasury Secretary Scott Bessent: in a fragmented world, regional economies must finance and drive their own growth through sovereign demand.

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An Internal Rebalancing

While the fiscal shift spans the continent, its central macro target is Germany. The country’s real GDP has been essentially flat since 2022, showing no meaningful growth for three consecutive years — a rare period of stagnation for Europe’s largest economy. The country has experienced economic stagnation since 2022, with weak exports, lackluster investment, and subdued domestic consumption. The new fiscal push is designed to address these internal weaknesses directly. Another critical piece of the puzzle is the revival of credit to the private sector. Lending remains weak across much of the euro area, particularly in Germany, where investment demand has softened and bank lending standards remain tight. To complement public investment, policymakers should consider targeted regulatory easing, such as relaxing capital buffers or recalibrating risk-weighted asset rules, to encourage bank lending and private sector expansion without undermining financial stability.

What makes Europe’s pivot distinct is how it contrasts with the U.S. While the U.S. is increasingly constrained on the fiscal side and facing political pressure to ease monetary policy that would lead to negative real rates, Europe is embracing fiscal expansion while maintaining positive real interest rates. The strong euro, bolstered by capital inflows into European assets, allows the ECB to stay flexible on rate cuts without losing credibility, a rare advantage in today’s global macro environment.

The United States and Europe are now pursuing fundamentally different macroeconomic strategies. In the U.S., fiscal tightening and a politicized Federal Reserve may produce much looser monetary conditions without fiscal reinforcement. In Europe, public investment is doing the heavy lifting, while monetary policy remains anchored by a credible central bank and a strong currency.

This structural shift toward sustained public investment comes with a long-term cost: rising debt levels. The average debt-to-GDP ratio in the euro area currently stands at 88%. If deficits rise to around 5% of GDP, as implied by rearmament, infrastructure, and strategic autonomy goals, and nominal growth averages 4.5% while interest rates stay near 3%, debt levels could rise to approximately 138% of GDP over the next decade.

This trajectory highlights the importance of anchoring the fiscal expansion in productive investment and credible growth strategies. Without offsetting productivity gains or new fiscal frameworks, the rising debt burden could become a renewed source of market and institutional stress. For now, Europe has political and monetary space to act, but the long-term arithmetic cannot be ignored.

Toward a Fiscal Union

To make this pivot sustainable, Europe will ultimately need to move toward a full fiscal union. That includes greater budgetary coordination, shared counter-cyclical tools, and most importantly, the creation of a unified eurozone bond market. Such a market would reduce borrowing costs, deepen capital markets, and provide a robust financial foundation for long-term strategic investment.

Without this step, the monetary union remains incomplete and vulnerable to asymmetric shocks and divergent fiscal capacities. Fiscal sovereignty at the national level must be balanced by collective responsibility at the European level. A common bond market is not just a financial tool; it is a political commitment to shared stability, security, and growth.