Fiscal aspects of European defence spending: implications for euro area macroeconomic projections and associated risks
Published as part of the ECB Economic Bulletin, Issue 5/2025.
Government defence spending in the EU is expected to rise in response to heightened geopolitical tensions, particularly following Russia’s unjustified invasion of Ukraine. This trend was reinforced by the NATO summit of 24-25 June 2025, at which NATO allies made a commitment to spend 5% of GDP on defence annually by 2035, of which 3.5% on core defence (up from the current guideline of 2%) and 1.5% on defence and security-related spending.[1] For most EU countries, the new target implies a substantial increase in defence spending. Evidence suggests a strong correlation between current levels of defence spending across EU NATO members and proximity to Russia – as an indicator of most imminent geopolitical risks – but also between defence spending and fiscal space (Chart A). According to the latest available NATO data for its members, defence spending at EU level stood at 2.0% of GDP in 2024, while the euro area aggregate was 1.9%.[2] Shortly after the Munich Security Conference in February 2025, the European Commission announced its “Readiness 2030” plan, which allows EU Member States more flexibility under the EU fiscal governance framework to facilitate the necessary shift in spending, as well as proposals to increase spending efficiency and reduce fragmentation in the EU defence sector through joint procurement.[3] This box explores the implications of the new defence plans announced since the Munich Security Conference for euro area baseline projections and the risks around the baseline over the period 2025-27, as reflected in the June 2025 Eurosystem staff macroeconomic projections.[4]
Chart A
Defence spending in EU NATO countries in 2024 and correlation factors
a) Distance from Russia | b) Government debt |
|---|---|
(x-axis: distance from capital to Moscow as an inverse proxy for risk, km; y-axis: 2024 defence spending, percentages of GDP) | (x-axis: 2021 gross government debt, percentages of GDP; y-axis: 2024 defence spending, percentages of GDP) |
 |  |
Sources: NATO, European Commission (AMECO) and ECB staff calculations.
Notes: Defence spending shown is NATO 2024 estimates (latest available update, 17 June 2024). Blue dots indicate euro area and yellow dots non-euro area EU countries that are also members of NATO. Panel a) shows a correlation coefficient of -0.64 between defence spending and distance from Russia. In panel b), the solid grey line shows a correlation coefficient of -0.21 between defence spending and government debt, while the steeper dashed line shows a correlation coefficient of -0.5 excluding Greece, which traditionally has high defence spending in light of risks centred on other sources. 2021 debt levels are used as a measure of “initial” fiscal space, i.e. before Russia’s full-scale invasion of Ukraine in early 2022, after which many countries increased their defence spending. Using 2024 gross government debt-to-GDP ratios would not change the overall picture significantly.
The fiscal impact of the new defence spending measures announced since mid-February, as factored into the June 2025 Eurosystem staff baseline projection, amounts to 0.6% of GDP cumulatively over 2025-27 (Chart B). In annual terms, the additional spending is projected to rise over time and to reach 0.3% of GDP in 2027 (Chart B, panel a). The new spending originates from eight euro area countries, with the bulk of it coming from Germany. This significantly raises the amounts already embedded in the baseline since 2022.[5] As well as national defence spending, the new measures include defence support for Ukraine (somewhat above 0.2% of GDP cumulatively over 2025-27, which is estimated to have no direct macroeconomic impact on euro area economies). In terms of the projected composition of new euro area national defence spending, more than half is allocated to government consumption – mainly intermediate goods (around 40%), followed by personnel expenditure (around 15%) – while around 40% (more than in the recent past) is directed towards investment (Chart B, panel b).
Chart B
Eurosystem estimates of new defence spending – euro area aggregate
a) Size of new defence spending
(percentages of GDP)
b) Composition of new national defence spending
(y-axis: percentages of GDP; in bars: share of new spending, percentages)
Sources: ECB staff calculations based on June 2025 Eurosystem staff projections.
Notes: Panel a) shows revisions in fiscal measures related to defence since the March 2025 ECB staff macroeconomic projections for the euro area. Panel b) excludes support for Ukraine (light blue bars in panel a).
The new defence spending is expected to provide some support to euro area growth in the baseline, particularly over 2026-27, while the impact on inflation is expected to be muted (Chart C). Eurosystem staff assess the impact on real GDP growth at close to 0.1 percentage points per year over 2026-27, with limited effects in 2025. The impact on inflation is expected to be muted over the projection horizon in the absence of a direct link to prices of consumer goods included in the Harmonised Index of Consumer Prices (HICP).[6] The inflation impact is likely to be lagged and to increase somewhat over time as indirect effects feed through via domestic demand and higher wages, but it is expected to remain small throughout 2025-27.
Chart C
Estimated macroeconomic effects of new defence spending – euro area aggregate
(percentage point deviations from baseline)
Sources: ECB staff calculations based on June 2025 Eurosystem staff projections.
Notes: The chart shows the euro area macroeconomic effects (growth and inflation) aggregated from country-specific results of macro model simulations conducted by Eurosystem staff. The “fiscal shock” (input used for macro simulations) is the annual change in the levels of additional spending shown in Chart B, panel a), excluding Ukraine support, which does not have a direct macroeconomic impact on euro area economies.
In terms of risks to the baseline, Eurosystem staff first assessed the defence spending risks stemming from actual government announcements at the cut-off date of the June 2025 projections, which were found to be relatively limited (Chart D). In country-specific risk scenarios, based on expert judgement on additional defence spending compared to the baseline, its composition and possible financing, the real GDP growth effects range between 0.06 and 0.12 percentage points per year over 2026-27, with a limited impact on inflation. The effects of additional defence spending tend to be lower when (i) the stimulus is partially financed through cuts in other spending instead of through the issuance of new government debt, and (ii) the defence spending has a higher import content than average government expenditure. On the other hand, given current labour market tightness, inflation effects could be higher if labour income expands more vigorously than under normal circumstances.
Chart D
Risks to the June 2025 projection baseline stemming from additional defence spending
(percentage points of GDP and percentage point deviations from the baseline)
Sources: ECB staff calculations based on Eurosystem staff risk assessments in the context of the June 2025 projections.
Notes: The left three columns show additional net defence spending (fiscal loosening “shocks” or changes per year). The range of the dark blue bars for these columns is given by the scenarios of additional defence spending with and without compensatory financing measures over the projection horizon. In the illustrative scenarios, the fiscal shocks (light blue bars) are without compensatory measures (full debt financing) over 2025-27. The range of macroeconomic results is based on ECB-BASE model simulations, keeping monetary policy, exchange rate and financial spreads fixed at their baseline values and varying the simulation set-ups (degree of import content, labour market tightness and, for the illustrative scenarios, yield effect).
Furthermore, based on Eurosystem staff expectations regarding the outcome of the June NATO summit, illustrative risk scenarios considered higher additional defence spending, which could yield more significant growth effects, while the impact on inflation, albeit increased, would remain limited over the projection horizon. These scenarios (also shown in Chart D), which informed the risk assessment in the June projections, assume a gradual increase in spending (tilted towards government investment) to 3% of GDP at euro area aggregate level by 2027. The scenarios yield larger effects on GDP growth (rising to 0.4-0.6 percentage points above the baseline in 2027) and somewhat higher inflation effects (about 0.1 percentage points in 2027). Such effects can be considered as upper bounds over 2025-27, as the scenarios are set up to allow the additional defence expenditure to be fully debt-financed. As before, the impact of the additional spending is simulated in different settings to construct a range of macroeconomic effects. For these scenarios, in addition to the higher import content of spending and tighter labour markets, a moderate increase in sovereign yields is considered, which lowers the output and inflation effects.[7]
The estimates presented in this box are subject to considerable uncertainty. As well as uncertainty regarding the actual build-up of defence capabilities and related fiscal spending (size, composition and timing of the measures), there is also considerable estimation uncertainty regarding fiscal multipliers of defence spending, where the empirical evidence is mixed.[8] Furthermore, the relatively high growth but low inflation impact of the additional defence spending over the projection horizon may warrant further analysis, considering, among other factors, the possible impact on the expectations of households and firms.[9] Finally, the risk analysis abstracts from possible financial market tensions if government debt ratios are not put on a declining path over the medium term, particularly in the highly indebted euro area countries and in the event of more adverse macroeconomic developments.
References
Baumann, A., Checherita-Westphal, C., Kocharkov, G. and Osterloh, S. (2025), “Higher defence spending and its impact on households’ expectations”, Economic Bulletin, Issue 5, ECB.
Bouabdallah, O., Checherita-Westphal, C., De Stefani, R., Haroutunian, S., Hauptmeier, S., Huber, C., Momferatou, D., Muggenthaler-Gerathewohl, P., Setzer, R. and Zorell, N. (2025), “Medium-term fiscal-structural plans under the revised Stability and Growth Pact”, Economic Bulletin, Issue 3, ECB.
López Vicente, F., Rodríguez-Vives, M. and Rojas, J. (2024), “Public spending on defence, public order and safety in Spain and the European Union”, Economic Bulletin, 2024/Q3, Banco de España, Article 5.
Ilzetzki, E. (2025), “Guns and Growth: The Economic Consequences of Defense Buildups”, Kiel Report, No 2, February.
See The Hague Summit Declaration of 25 June 2025. The 3.5% of GDP refers to core defence spending according to the current NATO data definition. The additional 1.5% of GDP refers to, among other things, spending to protect critical infrastructure, defend networks, ensure civil preparedness and resilience, unleash innovation, and strengthen the joint defence industrial base. The trajectory under the new investment plan will be reviewed in 2029.
It should be noted that NATO data on defence spending may differ significantly from EU data as recorded in national accounts (COFOG – the latest available data are for 2023) and used for fiscal projections and the monitoring of the EU fiscal rules under the Stability and Growth Pact. Methodological differences include, for example, the use of cash-based accounting (NATO) versus accrual (COFOG) and the inclusion of military pensions (NATO). For more details and an international comparison of defence spending, see López Vicente et al. (2024).
See the Commission press release of 19 March 2025. For more details, including an assessment of the impact on government debt of the additional fiscal flexibility, see Bouabdallah et al. (2025).
See Eurosystem staff macroeconomic projections for the euro area, June 2025, which include a first assessment of these defence plans (in addition to new infrastructure spending in Germany) for the projection baseline.
These amounts relate to (i) defence and other war-related support, including refugee spending, since Russia’s invasion of Ukraine in early 2022, and (ii) other increases in defence spending, mostly related to contracts signed before the invasion. Together with the new spending since mid-February 2025, the fiscal impact of these measures is estimated at around 0.6% of GDP in 2027, compared with 0.35% in 2024.
Higher demand for defence goods can have a direct short-term impact on the prices of these goods – reflected in higher government consumption and investment deflators – and hence on the GDP deflator.
The increase in average euro area long-term interest rates considered in this simulation is similar in magnitude to the increase observed when the German coalition agreement was announced in the spring of 2025.
Empirical literature on fiscal multipliers suggests that military spending can have favourable short-term demand effects, but – with the exception of research and development spending – its long-run growth effects tend to be muted. However, estimates of fiscal multipliers vary widely and are likely to be state, methodology and sample dependent. Among recent literature reviews, Ilzetzki (2025) finds consensus that GDP does increase in the wake of higher defence spending, but the degree of this expansion and the potential crowding out of the private sector remain unclear.
For more on household expectations, see Baumann et al. (2025) in this issue of the Economic Bulletin.