Germany’s leading institutes expect a slight recovery in the German economy in 2026 at the earliest, but even this will come at a heavy price.

Signs of hope for the German economy from a few months ago have already vanished. Leading economic research institutes lowered their economic forecasts for 2025 on Thursday.

According to an analysis in Handelsblatt, the Kiel Institute for the World Economy (IfW) now predicts that gross domestic product (GDP) will grow by only 0.1%.

The Essen-based Leibniz Institute for Economic Research (RWI) forecasts 0.2% growth, while the Ifo Institute also predicts 0.2% growth. The Halle Institute for Economic Research’s (IWH) growth forecast is also 0.2%.

At the beginning of the summer, they were forecasting average growth of around 0.3% for 2025.

The main reason for the downward revision is that the government’s stimulus measures have been less effective than previously predicted, and the electricity tax was reduced only for industry.

The institutes do not expect another recession—a contraction of economic output for two consecutive quarters—within this year.

Following a 0.3% fall in GDP in the second quarter, minimal growth is expected from the third quarter onwards.

However, according to the forecasts, there will be no stronger momentum after that.

This is not good news for the federal government. Chancellor Friedrich Merz had promised an “economic turning point” and made a return to growth his most important goal.

Germany’s GDP is currently at a level similar to that of 2019, before the coronavirus pandemic and the war in Ukraine.

“The driving forces for a self-sustaining recovery are still weak,” says IfW chief economist Stefan Kooths.

The low probability of this situation changing this year is likely to intensify debates within the federal government about economic policy reforms.

Although the institutes expect more growth in the years after 2025, a closer look at five points in the forecasts shows that this is no reason for enthusiasm.

1. The hope for growth: Revival will only come in 2026

Germany may experience a revival again starting next year.

The IfW expects growth of 1.3% in 2026. The institute’s initial forecast for 2027 is 1.2%.

The RWI forecasts 1.1% growth in 2026 and 1.4% in 2027.

The Ifo Institute expects 1.3% growth next year and 1.6% the year after.

The IWH, however, offers a much more pessimistic forecast, predicting 0.8% growth for 2026 and 0.6% for 2027.

The labor market will be the biggest beneficiary of this. Although the unemployment rate is still at 6.3% this year, it is projected to fall to 5.8% by 2027.

Compared to the forecasts made at the beginning of the summer, this still represents a setback. At that time, the institutes were expecting average growth of around 1.5% for next year.

2. Growth is financed by the state

In addition, next year’s revival will not only be smaller but will also come at a high price.

The federal government is artificially stimulating growth by significantly increasing debt in infrastructure and defense, and through energy price subsidies, super-depreciation for companies, and tax cuts for the restaurant sector and senior citizens.

The IfW estimates that the government will pump an additional 42 billion euros into the economy in this way by 2026. The forecast for 2027 is 22 billion euros.

According to the IfW’s calculations, the government’s expansionary fiscal policy alone accounts for 0.6 percentage points of the expected growth next year. In 2027, this figure will be 0.3 percentage points.

The RWI’s figures are similar: the institute estimates that government stimulus will boost growth by about 0.5 percentage points in both years.

The problem is that increased government spending does not automatically increase the economy’s growth potential. The numerous contracts the government will award may not lead to an expansion of production capacity but could instead cause prices to rise.

Germany is particularly exposed to this situation because the supply of additional labor is shrinking due to demographic change, and bureaucratic burdens and insufficient digitalization make capacity expansion unattractive.

“In the long run, state investments cannot replace private sector activity,” says RWI Chief Economist Torsten Schmidt.

This also overshadows the joy over the falling unemployment rate: new jobs are mostly being created in the government-related service sector, which is significantly less productive than German industry, where job losses continue.

At the same time, government spending is leading to significantly higher borrowing: according to the RWI, the general public deficit ratio—the ratio of the public sector’s annual new debt to economic output—will rise from 2% this year to 3.6% by 2027.

There is another special effect: in 2026, the number of working days will increase significantly, for example, because public holidays will more frequently fall on weekends. This effect accounts for another 0.3 percentage points of the projected growth in 2026.

“Without these effects, the remaining recovery would be extremely weak, so one cannot speak of a self-sustaining upswing,” write the IfW experts.

When these two effects are not taken into account, only 0.4% GDP growth remains as the “real recovery” in 2026.

The adjusted growth for 2027 is 0.8%. According to the RWI’s assumptions, the adjusted GDP change is only 0.3%. In 2027, this rate will be 0.8%.

The state-led recovery is also confirmed by private sector figures. According to the RWI, private sector investment in equipment will decrease by 2.3% in 2025 and will show only a moderate recovery of 2% and 1.7%, respectively, in the following years, despite improved depreciation conditions.

In contrast, government investment in equipment will increase by about 11% to 22% during the same period. Private consumption will not increase by even 1% next year and the year after, partly due to a slowdown in wage growth.

3. Brakes on growth: Underutilization of capacity

Apart from the record level of state orders, the economic environment remains complex.

There are several developments that hinder a “real revival” and cause German companies to produce far less than they currently could. According to Handelsblatt, the underutilization of capacity is among them.

One reason for this is the tariff agreement for exports to the US. The uncertainty surrounding this and the 15% tariffs are negatively affecting Germany’s exports, one of its most important activities.

According to IfW calculations, US tariffs will reduce economic output by 0.3% in 2025 and 2026, which is equivalent to 13 billion euros.

Another risk is the tension in international financial markets. Risk premiums on government bonds have increased significantly in recent days.

4. Industrial capacity is shrinking

On the other hand, an improvement in external conditions alone will not be enough for Germany to experience a real revival again.

The reason for this is that, parallel to the underutilization of the German economy’s capacity, the structure of the economy is also changing.

Production capacities are not only being underutilized but are apparently being permanently reduced. This means that even if the German economy returns to normal capacity utilization, higher growth rates may no longer be possible.

This is particularly true for industry. The value added of industry is currently more than 4% below the 2019 level. The IfW writes, “In this context, the extremely low capacity utilization may indicate that there is less room for economic recovery and instead points to a further reduction in production capacity.”

According to the RWI, another piece of evidence for this is that although companies’ business expectations for the next six months have recovered slightly, they still assess their situation as poor.

According to the economists, companies are pinning their hopes more on government programs than on an improvement in local conditions.

5. Reforms to slow down structural change

According to the institutes, “structural reforms” that allow for capacity development are necessary to stop this trend.

If this happens, the numerous government contracts resulting from new debt could also ensure that this leads to sustainable growth.

The economists primarily recommend reforms for the social security systems and energy policy. RWI expert Schmidt says, “The government’s spending programs can stabilize the economy in the short term, but they do not solve the fundamental competitiveness problems of the German economy.”

In social policy, it is argued that systems should be designed to encourage more citizens to work in order to slow the decline of the working population for demographic reasons.

According to the institutes, the priority in the energy sector should be to lower energy prices in Germany and increase the security of supply to stop the migration of companies to countries with better energy resources.

Experts believe that structural regulations in the energy market are more important than energy price subsidies.