Internally, the defeats in Italy convinced Francis Joseph that neoabsolutism had failed. Clamour for economic, political, and even military rejuvenation became irresistible. In March 1860 Francis Joseph ordered that the Reichsrat, an empirewide, purely advisory council of state, be enlarged by the addition of 38 members proposed by the provincial diets and selected by the crown. Its main task was to advise the emperor on the composition of a new constitution. The body divided into two groups rather quickly. One, made up mostly of German-speaking delegates, wished to create a strong central parliament and to continue to restrict the power of the provincial governments. The other, made up of conservative federalists who were largely Hungarian, Czech, and Polish nobles, wished to weaken the central government and give considerable power to the provinces. The emperor sided with the federalists, who persuaded him to accept their position mainly with historical and not ethnic arguments, and he proclaimed by decree a constitution called the October Diploma (1860). The constitution established a central parliament of 100 members and gave it advisory authority in matters of finance, commerce, and industry. Authority in other internal matters was assigned to the provinces. Foreign policy and military issues remained the domain of the emperor.

No one was happy with the October Diploma. The German centralists opposed it for giving too much authority to the provinces, and the federalists, particularly the Hungarians, opposed it for not restoring fully the old rights and privileges of the crown lands. Faced with such opposition, Francis Joseph abandoned the Diploma and four months later issued the February Patent (1861), officially a revision of the Diploma. This document provided for a bicameral system: an empirewide house of representatives composed of delegates from the diets and a house of lords consisting partly of hereditary members and partly of men of special distinction appointed for life. Furthermore, a separate parliamentary body for the non-Hungarian lands was established.

The February Patent restored much authority to the central government and so made the centralists happier, but it only antagonized further the federalists, now led enthusiastically by the Hungarians. Resistance was so great that by 1865 the constitution was considered unworkable, and Francis Joseph began negotiations with the Hungarians to revise it. In the meantime, a form of government by bureaucracy ran the country.

These constitutional issues received a significant jolt by another failure of Habsburg foreign policy. After the disbandment of the Frankfurt National Assembly in 1849, the German Confederation founded in 1815 had resumed its work, but the question of German unification had not gone away. In 1862 this issue gained an unlikely champion in the appointment of Otto von Bismarck as prime minister of Prussia and later chancellor of the German Empire. Bismarck was a Prussian patriot and a loyal subject of his king. While definitely not a German nationalist, he was determined to extend Prussia’s power and authority into the German lands, and he knew that Prussia could expand its influence in Germany only at Austria’s expense. From 1862 to 1866 he conducted a remarkably deft foreign policy that succeeded in isolating Austria from possible allies in Europe.

By exploiting issues in the German Confederation, Bismarck was able in 1866 to force Austria into a position that could only be resolved by war. The conflict is known as the Seven Weeks’ War or the Austro-Prussian War. On July 3, 1866, the two armies clashed in this struggle’s only major Austro-Prussian battle, the Battle of Königgrätz, or Sadowa as it is known in Austrian histories. Although the battle was hard fought on both sides, the arrival of an extra Prussian force toward the end of the day decided it in favour of Prussia. Afterward, peace came quickly, because neither side wanted the war to continue. As Austria had been excluded from the future of Italy in 1859, so it was now excluded from the future of Germany. The German Confederation came to an end, and Prussia was allowed a free hand in reorganizing northern Germany as it wished (see North German Confederation). Moreover, Italy had joined Prussia against Austria and, although defeated on land and sea, received Venetia, Austria’s last possession in Italy, for its loyalty. Internally, the war meant that the government had to reach a constitutional arrangement for the remainder of its possessions.