When I wrote that Germany has the fiscal capacity to increase spending on defense and infrastructure reconstruction, I had this in mind. Germany has a much smaller public debt compared to other large EU members (France, Italy, Spain) and a smaller budget deficit, so it is one of the few large economies that can now "pull".
France and Italy, for example, do not have the capacity for such a thing. Their budget deficits and public debt are such that the market would show a "red light" immediately to any similar attempt to stimulate the economy.
On what basis do I claim this? Well, we have a recent example from the UK a little over two years ago. British Prime Minister Liz Truss proposed a large tax relief, the abolition of the highest income tax rate, etc., which would worsen budget deficits that were already around 5% of GDP. The bond market went crazy, yields on British bonds jumped sharply, pension funds ran into problems, the Bank of England had to react, etc. General chaos. The market reaction was so strongly negative that Liz Truss could not calm her down, neither by changing the finance minister, nor by withdrawing most of the proposals, nothing. She had to resign and thus became the person with the shortest prime ministership in the history of British politics.
So, the market reaction was the exact opposite of the reaction to this German fiscal stimulus. For the UK, the market considered the plan bad (despite the positive effects that tax relief would have in the short term) because it is unsustainable in the long term given the current level of public debt of around 100% of GDP and a deficit of 5%, while for Germany the market gives the green light. Because the Germans saved when they needed to (they had budget surpluses in the years before the corona).
And just a response to those who think that I am "celebrating" the increase in government spending. First, I am not celebrating anything, I am just explaining why the market reacted the way it did and why the presented plan makes sense. Second, this planned increase in state spending does not go into increasing salaries in state and public services, increasing social expenditures, pensions, etc., but rather investments in INFRASTRUCTURE (energy, renovation of the power grid, railways, roads, etc.) and DEFENSE. These are the basic functions of the state.
Germany currently spends shamefully little on defense, just 1.5% of GDP. This is below the NATO standard of 2%, twice less than the USA (3% of GDP), four times less than Russia (6% of GDP), etc. If we lived in la-la land, that would be ok. But we are not, the reality is that we have the bloodiest war in Europe since the Second World War, therefore increasing the allocation for defense is a necessity (pledge for a safer future).
To conclude, I do not know what the final effect of the German fiscal stimulus will be, that is, whether in five years the positive effects will outweigh the potentially negative ones (say, a possible flare-up of inflation). The point is that the market, at least for now, is giving them the green light. We will see what the implementation of the plan will be like in reality.
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