IMK Report: Germany’s Economic Outlook – Yellow Light

The German economy is stagnating, warns the IMK in a current report. The industrial core is at risk, while defense spending is exacerbating the situation.

At the beginning of the year, the Böckler Foundation’s Institute for Macroeconomics and Economic Research in Duisburg looks at the development of growth, debt and inflation in the Federal Republic of Germany.

The studies tend to point to a continuation of stagnation with moderate potential and sustained threats to further economic development. The influence of arms spending is viewed rather negatively, but is not politically condemned.

Industrial core at risk – but can still be saved

“Modernize Germany’s industrial core and increase prosperity” is the title of the IMK report in January 2026. Tom Bauermann, Katja Rietzler and other IMK economists provide an outlook on economic policy challenges, missed opportunities of the past year and rays of hope for the coming year.

In the report, after 3 years of crisis, they call for rapid and strategic action through expansionary fiscal policy and targeted government investments. The industrial core can only be preserved through a holistic industrial policy for key future and key sectors. In addition to the transformation to climate neutrality, the hydrogen sector is particularly important.

A “central prerequisite for the sustainable reform of the Germany model” is a further easing of the debt brake. The ECB also has to act: While – as comprehensively explained in the previous report – US tariffs and the appreciation of the euro had a negative impact on industrial exports, the ECB could use the relatively relaxed inflation situation for monetary policy measures.

While the IMK outlines possibilities for reforming the industrial core of the German economy, it also urgently warns against further misconduct. The manufacturing sector’s share of gross value added was 19.7 percent in 2024, which was still relatively high compared to international standards, but has also fallen faster than the EU average since 2018.

There is a risk of a fundamental loss of substance: “The longer the economic stagnation and in particular the decline in industrial production continues, the greater the risk that existing, fundamentally productive structures will break down and skilled workers will be released into unemployment or early retirement, with lasting negative consequences for Germany’s future prosperity.”

Armament slows growth and increases debt

On the other hand, the loan-financed spending programs for armaments have a rather counterproductive effect on overall economic development, as can be seen from the report and also a policy brief from the IMK in January 2026. Christoph Paetz, Katja Rietzler and Sebastian Watzka used three scenarios to determine that real GDP could grow 0.5 to 1 percent faster without credit-financed spending programs than with them.

According to joint calculations by the IMK and the Institute for Economics (IW) in Cologne, a loan-financed investment program worth 600 billion euros could “significantly improve Germany’s economic development without endangering the long-term sustainability of public finances.” Without the loan-financed spending programs in the area of ​​armaments, the budget deficit and the debt ratio “increased only temporarily and moderately”.

If, on the other hand, the defense sector is financed permanently through debt, a positive impact on GDP can be expected in the short term, but in the longer term the financial situation for the German tax authorities will deteriorate significantly. In the medium and long term, private investments would also lag behind because “with the permanently high level of new debt, interest rates would also rise and private investments would therefore become less attractive.”

On the basis of this analysis, however, the IMK does not call for comprehensive military spending to be stopped, but rather formulates it as follows: “Accordingly, a stability-oriented German fiscal policy would be well advised to finance permanently high defense spending – if it is politically necessary and desired – not just by taking on new debt, but to a significant extent through taxes. Long-term debt financing should only be made possible with additional investment spending by the state.”

Uncertain economy – risk of recession still present

For the next three months of 2026, the IMK expects a “continuation of a moderate growth regime” with high uncertainty. This emerges from the IMK economic indicator in January 2026.

Due to a slight deterioration in sentiment indicators – such as the ifo business climate index, the GfK consumer climate index and the S&P purchasing managers index – the probability of recession has increased slightly. The downward trend in exports to countries outside Europe is also slowing down economic growth.

In contrast, a moderate upswing in the domestic economy contributed to growth. “The recent upward movements in production, truck toll mileage index and incoming orders from the domestic manufacturing sector” gave rise to hope.

However, one should not be too optimistic. Leading indicators related to private consumption, such as retail sales, continue to trend sideways rather than upwards.

The reports can be viewed – along with other studies and data sets – on the IMK homepage. In particular, the findings on labor market and pension developments need to be examined more closely in the light of current debates.