The collapse of the SPD–Greens–FDP traffic-light coalition in November 2024 was neither sudden nor unexpected. The proximate cause was the FDP's withdrawal over the supplementary budget needed to fund Ukraine support without triggering the constitutional debt brake, but the underlying fracture was structural: three parties with incompatible fiscal philosophies attempted to govern through a war, an energy shock, and a manufacturing downturn simultaneously, and the coalition contract was never updated to accommodate any of them.
The February 2025 snap election produced a Bundestag of five parties of meaningful size: CDU/CSU at 28.5 percent, AfD at 20.8 percent, SPD at 16.4 percent, Greens at 11.6 percent, and the new Sahra Wagenknecht Alliance (BSW) at 4.9 percent — narrowly below the five-percent threshold and therefore absent from the chamber. The FDP fell beneath the threshold for the first time since 2013. The Left Party, written off by most pollsters, surged in the final week and entered the Bundestag with 8.8 percent on the strength of an unusually effective ground operation in Berlin, Leipzig and university constituencies.
Friedrich Merz, who had spent two decades outside frontline politics before reclaiming the CDU chairmanship in 2022, formed a grand coalition with the SPD by early May 2025. The Koalitionsvertrag committed to four headline priorities: a substantial increase in defense spending toward a sustained 3 percent of GDP, modernization of the debt brake to permit infrastructure and defense investment, reform of citizen benefits (Bürgergeld), and a recalibration of asylum and migration policy. The agreement was ratified with significant unease inside the SPD parliamentary group, and the first six months of the coalition have been marked by quiet but persistent intra-coalition tension over the pace and substance of welfare reform.
The constitutional dimension is the most significant. In March 2025, the outgoing Bundestag — at the insistence of Merz and with SPD and Green support — amended the Basic Law to exempt defense spending above one percent of GDP from the debt brake and to create a €500 billion off-budget infrastructure fund. This was an extraordinary act of fiscal hawkishness reversal by a CDU leader whose political identity was built around the debt brake, and it was justified explicitly by the changed transatlantic environment.
That transatlantic environment is the second analytical thread. The Merz government's first foreign policy act was a coordinated statement with Paris and Warsaw on European strategic autonomy, framed not as a break with NATO but as a hedge against a U.S. administration whose commitment to Article 5 enforcement against a Russian probe in the Baltic states could no longer be assumed. The European Sky Shield Initiative has been operationalized, German procurement of additional Patriot batteries and the Arrow-3 system has been accelerated, and the Bundeswehr's planned end-strength has been raised from 203,000 to 230,000 by 2031.
The AfD's 20.8 percent performance, and its first-place finish in Thuringia, Saxony and parts of Brandenburg, has dominated international coverage but is often misinterpreted. The party's geographic concentration in the new states, its weakness in the south outside specific Bavarian districts, and the firewall (Brandmauer) maintained by all other parliamentary groups together mean that the AfD remains excluded from coalition formation at the federal level. It does, however, structure the policy environment by pulling the CDU/CSU rightward on migration, internal security and EU integration.
On migration, the Merz government has implemented permanent border controls at all internal Schengen frontiers, expanded the list of safe countries of origin, and accelerated returns to Turkey, Iraq and the Maghreb under bilateral arrangements. The European Commission has tolerated the Schengen derogations under the framework of the 2024 Migration and Asylum Pact's exceptional provisions but has signaled that legal challenges are likely if the controls extend into 2027. Asylum applications fell 32 percent year-on-year in 2025, although the German Institute for Employment Research estimates that approximately 400,000 net working-age migrants per year remain necessary to stabilize the labor force.
On industrial policy, the government has launched a 'Standort Deutschland' initiative combining electricity-price subsidies for energy-intensive industry, accelerated permitting under the EU Net-Zero Industry Act, and a targeted investment program for battery, semiconductor and pharmaceutical capacity. Volkswagen's announced restructuring — closure of three German plants and 35,000 job reductions through 2030 — has been the dominant case study of German manufacturing's structural challenge. The government has resisted direct firm-level intervention but has provided indirect support through energy pricing and procurement.
On Russia and Ukraine, the Merz government has been more forward-leaning than its predecessor. Delivery of Taurus cruise missiles, blocked by Chancellor Scholz, was authorized in June 2025. Bilateral security agreements with Kyiv have been extended through 2035, and Germany has become the largest single European contributor to the European Peace Facility's Ukraine envelope. The political risk inside the SPD parliamentary group on this dimension is real but contained.
Three implications for European political economy follow. First, the German fiscal pivot is the single most important development for the eurozone's medium-term outlook. The combination of debt-brake reform, the infrastructure fund, and sustained defense spending will deliver a fiscal impulse of roughly 1.2 percent of GDP per year through 2028 and pull the EU's effective fiscal stance into expansionary territory for the first time since 2009. Bund yields will trend higher, the euro will likely strengthen against the dollar, and peripheral spreads will widen modestly.
Second, the Franco-German engine is functional again but transactional. Merz and Macron have aligned on defense, capital markets union, and a pragmatic posture toward China, but diverge sharply on agriculture, fiscal rules, and the future of nuclear power. The relationship looks less like the Mitterrand–Kohl partnership and more like Schmidt–Giscard: substantive when interests align, neutral otherwise.
Third, the AfD is now a structural feature of German politics, not a cyclical protest phenomenon. The 2027 state elections in Saxony-Anhalt and Mecklenburg-Vorpommern will be the next inflection points, and the constitutional question of whether to pursue a formal AfD ban under Article 21(2) Basic Law has moved from the margins of legal scholarship to active political discussion. Veritas Global Advisory's Europe & Eurasia desk will publish a dedicated briefing on the AfD ban question and its political economy implications in Q2 2026.
This research briefing is published by Veritas Global Advisory's editorial desks. Views expressed are those of the authors and do not constitute investment advice.