European Parliament ECON Committee study in Brussels; Macroeconomic and fiscal implications of structurally higher defence spending in the European Union; long-run consolidation pressures rise after 2028

Macroeconomic and fiscal implications of structurally higher defence spending in the European Union

Economic Governance and EMU Scrutiny Unit (EGOV) Directorate-General for Economy, Transformation and Industry PE 784.024 – September 2026 EN

Macroeconomic and fiscal implications of structurally higher defence spending in the European Union STUDY Requested by the ECON committee

External author(s): Philipp HEIMBERGER Meryem GÖKTEN Juliane UNGER

ECTI | Economic Governance and EMU Scrutiny Unit (EGOV)

2 PE 784.024

Macroeconomic and fiscal implications of structurally higher defence spending in the European Union

PE 784.024 3

Abstract By temporarily exempting additional defence expenditure from fiscal adjustment requirements within defined limits, the National Escape Clause reduces the need for offsetting spending cuts or tax increases over 2025–2028. We analyse how much fiscal consolidation pressures under EU fiscal rules could increase after 2028, once the clause expires and higher defence spending becomes a permanent feature of national budgets requiring financing. We examine key factors shaping how higher defence expenditure affects macroeconomic and fiscal outcomes across EU member states. This document was provided by the Economic Governance and EMU Scrutiny Unit at the request of the ECON Committee.

Macroeconomic and fiscal implications of structurally higher defence spending in the European Union

ECTI | Economic Governance and EMU Scrutiny Unit (EGOV)

4 PE 784.024 This document was requested by the European Parliament’s Committee on Economic and Monetary Affairs.

AUTHOR(S) Philipp HEIMBERGER, The Vienna Institute for International Economic Studies (wiiw) Meryem GÖKTEN, The Vienna Institute for International Economic Studies (wiiw) Juliane UNGER, The Vienna Institute for International Economic Studies (wiiw) CONTACTS IN THE EUROPEAN PARLIAMENT Coordination: Giacomo LOI, Ronny MAZZOCCHI Editorial assistance: Ovidiu TURCU To give feedback or obtain copies, please write to: egov@ep.europa.eu VERSION Original: English Manuscript completed in August 2026 BIBLIOGRAPHIC REFERENCE FOR THIS PAPER Heimberger, Philipp; Gökten, Meryem, Unger, Juliane. 2026. Macroeconomic and fiscal implications of structurally higher defence spending in the European Union, Brussels: European Parliament, EGOV. For in-text citations: Heimberger, Gökten and Unger, 2026

DISCLAIMER The opinions expressed in this publication are those of the author(s) only and should not be considered as representative of the European Parliament’s official position.

ARTIFICIAL INTELLIGENCE Generative AI tools (GPT 5.6 Thinking) were used only to support language editing of the text. The scientific content of the paper, including the research questions, conceptual framework, methodology and analyses, was developed entirely by the researchers. No generative AI tools were used to generate research ideas. COPYRIGHT © European Union, 2026 LICENCE The reuse of this document is authorised under a Creative Commons Attribution 4.0 International (CC-BY 4.0) licence (https://creativecommons.org/licenses/by/4.0/). To use or reproduce elements that are not owned by the European Union, permission may need to be sought directly from the respective rightholders.

Macroeconomic and fiscal implications of structurally higher defence spending in the European Union

PE 784.024 5 ABOUT THE EDITOR The Economic Governance and EMU Scrutiny Unit provides in-house and external expertise to support EP committees and other parliamentary bodies in shaping legislation and exercising democratic scrutiny over EU internal policies. To contact Economic Governance and EMU Scrutiny Unit or to subscribe to its newsletter please write to: Economic Governance and EMU Scrutiny Unit European Parliament B-1047 Brussels E-mail: egov@ep.europa.eu Manuscript completed in August 2026 © European Union, 2026

IDENTIFIERS Print ISBN 978-92-848-4282-7 | doi:10.2861/0892504 | QA-01-26-298-EN-C PDF ISBN 978-92-848-4281-0 | doi:10.2861/9955990 | QA-01-26-298-EN-N

ECTI | Economic Governance and EMU Scrutiny Unit (EGOV)

6 PE 784.024 CONTENTS LIST OF ABBREVIATIONS 7 LIST OF FIGURES 8 LIST OF TABLES 8 EXECUTIVE SUMMARY 9

INTRODUCTION 10

EU FISCAL RULES AND DEFENCE SPENDING UNDER THE NATIONAL ESCAPE CLAUSE 11 2.1. The national escape clause and the reformed EU fiscal framework 11 2.2. Defence spending across EU member states 12

ASSESSING THE NATIONAL ESCAPE CLAUSE FOR DEFENCE SPENDING 15

FISCAL CONSOLIDATION PRESSURES WITH STRUCTURALLY HIGHER DEFENCE SPENDING UNDER EU FISCAL RULES 17

MACROECONOMIC EFFECTS OF HIGHER DEFENCE SPENDING 21

PUBLIC DEBT TRAJECTORIES WITH ALTERNATIVE ASSUMPTIONS ON DEFENCE MULTIPLIERS AND INTEREST-GROWTH DIFFERENTIALS 23

BENEFITS AND LIMITATIONS OF COORDINATED EU DEFENCE SPENDING AND FINANCING 27

RECOMMENDATIONS 28

CONCLUSIONS 29 REFERENCES 30 ANNEX 33

Macroeconomic and fiscal implications of structurally higher defence spending in the European Union

PE 784.024 7 LIST OF ABBREVIATIONS AMECO Annual Macro-Economic Database COFOG Classification of the Functions of Government DSA Debt Sustainability Analysis ECB European Central Bank EDF European Defence Fund EDP Excessive Deficit Procedure ESA European System of Accounts EU European Union GDP Gross Domestic Product IMF International Monetary Fund MTFSP Medium-term Fiscal-Structural Plan NATO North Atlantic Treaty Organization NEC National Escape Clause R&D Research & Development SAFE Security Action for Europe SGP Stability and Growth Pact SPB Structural Primary Balance SIPRI Stockholm International Peace Research Institute TFEU Treaty on the Functioning of the European Union TPI Transmission Protection Instrument

ECTI | Economic Governance and EMU Scrutiny Unit (EGOV)

8 PE 784.024 LIST OF FIGURES Figure 1: Defence spending in % of GDP in EU countries (2021 vs. 2024) 13 Figure 2: Structural primary balance (SPB) required at the end of the adjustment period to keep the public debt ratio on a plausibly downward trajectory assuming additional defence spending under the NEC 19 Figure 3: Sensitivity of the public-debt-to-GDP ratio to deviations in the interest–growth differential under alternative assumptions about the effects of additional defence spending 25 Figure 4: Sensitivity of the public-debt-to-GDP ratio to alternative defence spending multipliers 26

LIST OF TABLES Table A.1: DSA-based structural primary balance (SPB) targets to keep the public debt ratio on a plausibly downward trajectory 33

Macroeconomic and fiscal implications of structurally higher defence spending in the European Union

PE 784.024 9 EXECUTIVE SUMMARY Europe is moving towards a lasting increase in defence expenditure. Russia’s full-scale war against Ukraine and growing doubts about the durability of US security commitments are placing the governments of EU member states under mounting pressure to rearm. Against this background, this study assesses the macroeconomic and fiscal implications of structurally higher defence spending across the EU. The European Commission has introduced several initiatives to provide greater flexibility for additional defence expenditure, including a coordinated invitation for EU member states to activate the national escape clause (NEC) under the EU fiscal framework, which 18 member states have taken up so far. The NEC allows member states to deviate temporarily from their agreed expenditure paths by up to 1.5% of GDP per year over the period 2025-2028, provided that the deviation reflects additional defence spending. More recently, the NEC has been broadened, subject to specific limits, to cover fiscal measures aimed at reducing dependence on imported fossil fuels. While the NEC provides temporary flexibility, it is not designed to accommodate a structural increase in defence spending, for which durable financing solutions remain lacking. We provide a quantitative assessment of how fiscal consolidation pressures could increase after 2028, once the NEC expires and higher defence spending becomes a permanent feature of national budgets requiring financing. We show that the expiry of the NEC would increase fiscal consolidation pressures in countries that use the flexibility to raise defence expenditure, including high-debt member states that already face significant adjustment requirements even without additional defence spending. To assess the effects of higher defence expenditure on macroeconomic and fiscal outcomes, we review the relevant literature, focusing on short- and long-run output effects, inflationary pressures and sovereign borrowing costs. Financing higher defence expenditure through tax increases or cuts to other public spending once the NEC expires could weaken economic activity and trigger political opposition, thereby raising the risk of instability. Moreover, unless EU member states limit non-productive defence spending and place greater emphasis on investment and innovation, the output gains are likely to remain modest at best. Based on this review, we provide a quantitative assessment of how defence spending may affect public debt ratios under different assumptions about its impact on economic output and the interest-growth environment. Our results suggest that upward pressures on public debt will be stronger unless policymakers organise the military build-up in ways that enhance its growth effects and contain increases in sovereign borrowing costs. Implementing current commitments to structurally increase military spending would be difficult to reconcile with the EU fiscal framework’s core objective of placing public debt ratios on a plausibly declining trajectory. We conclude with five recommendations: First, use NEC flexibility selectively to avoid financing poorly targeted defence expenditure and future fiscal adjustment pressures; second, allocate part of it to productive energy-security investment to improve overall macroeconomic and public debt outcomes; third, strengthen European coordination and common financing to reduce procurement costs, limit borrowing-cost disparities and enhance overall macroeconomic gains; four, adapt the EU fiscal framework to provide a credible long-term response to structurally higher defence expenditure; and fifth, strengthen European Parliament scrutiny of the NEC and its post-2028 implications.

ECTI | Economic Governance and EMU Scrutiny Unit (EGOV)

10 PE 784.024 INTRODUCTION Europe is entering a period of structurally higher defence spending. Russia’s war against Ukraine, rising geopolitical tensions, growing cyber and hybrid threats, and increasing uncertainty about the long-term security guarantees provided by the United States have fundamentally altered the European security environment (e.g. Wolff et al. 2025; Hildebrand et al. 2026). After decades of comparatively low military expenditure and reliance on external security protection, European governments are now under strong pressure to rebuild military capabilities and strengthen the continent’s defence industrial base. The European Commission has launched the “Readiness 2030” agenda and initiated greater flexibility for defence expenditure, including a coordinated invitation for EU member states to activate the national escape clause (NEC) under the reformed EU fiscal framework (European Commission 2025a). The NEC for defence expenditure allows Member States to temporarily deviate from agreed expenditure paths by up to 1.5% of GDP annually between 2025 and 2028 to accommodate higher defence expenditure (Council of the European Union 2026). Structurally higher defence expenditure