Isabel Schnabel: Fiscal Challenges Amid Geopolitical Uncertainty and Ageing Societies

Why It Matters

The fiscal dynamics will shape growth prospects, debt sustainability, and the euro’s role as a global reserve currency, influencing policy decisions across the bloc.

Key Takeaways

• Low debt correlates with low public investment across euro area
• Germany's defence/infrastructure boost could raise GDP, increase debt
• Ageing populations raise interest costs, slow potential growth
• Sovereign spreads converging, indicating euro‑area confidence
• Euro gaining safe‑haven status, larger share of global reserves

Pulse Analysis

The euro area faces a paradox: many member states carry modest debt‑to‑GDP ratios while public investment remains subdued. This mismatch limits productivity gains and hampers the capacity to absorb shocks from geopolitical tensions and demographic shifts. As populations age, pension liabilities and interest expenses rise, eroding fiscal buffers and constraining potential output growth. Policymakers must therefore balance debt prudence with targeted investment to sustain long‑term prosperity.

Germany’s latest fiscal package illustrates this balancing act. By allocating additional funds to defence and infrastructure, the government aims to stimulate demand and improve potential growth. Projections show a modest GDP uplift, yet debt‑to‑GDP ratios climb, especially under scenarios that relax the Stability and Growth Pact (SGP) rules. The package’s design—whether fully investment‑led or mixed with consumption—determines its impact on fiscal compliance and future consolidation needs, underscoring the trade‑off between short‑term stimulus and long‑term fiscal discipline.

Market reactions reinforce the narrative of growing confidence. Sovereign spreads across the euro area have narrowed, reflecting reduced perceived risk despite higher spending. Simultaneously, the euro’s safe‑haven credentials are strengthening, as evidenced by tighter co‑movement with low‑risk assets and an expanding share of global foreign‑exchange reserves. This dual trend—tightening spreads and a stronger reserve currency—signals that investors view the euro zone’s fiscal adjustments as manageable, bolstering its attractiveness in a volatile international environment.

Isabel Schnabel: Fiscal challenges amid geopolitical uncertainty and ageing societies

Isabel Schnabel · Member of the Executive Board of the ECB · 18 February 2026 · Berlin‑Brandenburg Academy of Sciences and Humanities in cooperation with ESMT Berlin

Low German debt‑to‑GDP ratio went along with low public investment

• Public debt (percent of GDP) and public investment (percent of GDP) are shown for euro‑area countries.

• The range indicates the minimum and maximum values across all euro‑area members.

• Figures for 2026 and 2027 are based on the European Commission’s 2025 Autumn forecast (latest observation: 2027 projection).

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Fiscal package supports growth, with impact depending on the allocation of spending

Germany: Impact of additional defence and infrastructure spending on GDP (percent of GDP)

• Charts display the projected effect of extra defence and infrastructure spending on German GDP from 2025 to 2028.

Germany: Impact of additional defence and infrastructure spending on public debt (percent of GDP)

• Sources: Bundesbank Monthly Report – December 2025 (left chart) and COM projections together with ECB staff calculations (right chart).

• The right‑hand chart uses the European Commission’s Autumn Forecast up to 2027 and considers three scenarios:

  1. Partial SGP compliance with an investment‑led package (100 % productive public investment, positive impact on potential growth).

  2. Partial SGP compliance with a mixed composition (50 % government consumption, lower growth impact).

  3. No additional consolidation (same composition as the mixed scenario, fiscal stance unchanged apart from the package cost).

• Under minimum SGP compliance, Germany is assumed to stay within the allowed deviation of 0.6 % of GDP, with a national escape clause for an extra +1.5 % of defence spending.

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Rising fiscal challenges from higher expenditures and slowing growth in ageing society

• Government interest expenditures (percent of GDP) – based on ESCB DSA using the Autumn 2025 European Commission forecasts.

• Potential GDP growth in Germany (annual percentage changes) – derived from December 2025 Eurosystem staff projections.

• Total Factor Productivity, Capital, Labour, and Potential output growth – projections illustrating the drivers of potential growth.

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Converging sovereign spreads signal confidence in the euro area’s stability

• Spread of 10‑year euro‑area government bond yields vs. OIS rate (basis points) – latest observation 16 February 2026.

• Change in 5‑year euro‑area sovereign yields since January 2025 (basis points) – based on Bloomberg, LSEG, CMA, Tradeweb and ECB calculations. The decomposition includes risk‑free rate, default risk, redenomination risk, liquidity, and convenience premia (Corradin S. & Schwaab B., 2023).

• German fiscal package impact on yields – shows the movement of German, French, Italian, and Spanish 5‑year yields relative to risk‑free components.

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Euro increasingly acts as “safe haven”, strengthening its international role

• Co‑movement of financial assets with the “safe‑haven factor” (index) – derived from Haver Analytics and ECB staff calculations. The analysis uses principal‑component weights of ten‑year government yields (US, Germany, France, Italy, Spain), net effective exchange rates (CHF, JPY, EUR, USD), gold price returns, and the VIX. Data cover 1 January 2006 – 31 March 2025 (blue dots: since 1 April 2025). Latest observation 16 February 2026.

• Share in global foreign‑exchange reserves (percentages; constant Q3 2025 exchange rates) – IMF and ECB staff calculations. Other currencies include the pound sterling, Swiss franc, Japanese yen, Australian dollar, Canadian dollar, and Chinese renminbi. Latest observation Q3 2025.

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End of article.