Joint Economic Forecast Spring German Economy Recovering Long-Term Approach Needed to Economic Policy

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1 Joint Economic Forecast Spring 2013 German Economy Recovering Long-Term Approach Needed to Economic Policy Press version Embargo until: Thursday, 18 April 2013, a.m. CEST Joint Economic Forecast Project Group Completed in Halle (Saale) on 16 April 2012

2 German Economy Recovering Long-Term Approach Needed to Economic Policy An upwards tendency re-emerged in the German economy in spring The situation in the financial markets has eased thanks to subsiding uncertainty regarding the future of the European Monetary Union. The headwind in the world economy has also tailed off somewhat. The institutes expect gross domestic product in Germany to increase by 0.8% this year (68%-projection interval: 0.1% to 1.5%) and by 1.9% next year. The number of unemployed should continue to fall to an annual average of 2.9 million this year and 2.7 million in The inflation rate is expected to drop to 1.7% this year and edge up to 2.0% next year on the back of rising capacity utilisation. The public budget will be almost balanced in 2013 and should show a surplus of 0.5% in relation to gross domestic product in 2014 thanks to more favourable economic conditions. It is now time to readopt a longer-term approach to economic policy. Although structural adjustment processes implemented in the crisis-afflicted countries have started to deal with institutional problems in the euro area, they are far from resolved. The German public budget also faces massive long-term burdens related to demographic factors. In spring 2013 the world economy revived somewhat. The expectations of companies and consumers have improved since autumn and both industrial production and world trade have picked up in recent months. This is due in no small measure to the perception that there is a lower risk of the euro area breaking up after ECB intervention. The banking and financial crisis in Cyprus does not seem to have fundamentally changed this perception. The conditions in the financial markets have improved significantly since last autumn. Tensions in the euro area, which mounted in the first six months of 2012 after a renewed intensification of the government debt crisis, eased considerably. Share prices in the advanced economies have risen sharply since mid-2012 and recently hit long-term highs in several countries. Burdens, however, remain. The private sector in several advanced economies is still struggling to align its debt levels withthe lower long-term revenue forecasts resulting from the global financial crisis. The adjustment process is not yet complete and should continue to curb the economy, even if there are signs of burdens easing in the USA. 2

3 There was also no major improvement in the situation of national budgets in the advanced economies in the fourth year after the Great Recession. In view of mainly weak, and in some cases even deeply recessionary economic developments, progress in reducing national budgets has also been slow. Moreover, there are signs that austerity policy is being relaxed in some countries. In the euro area financial policy is expected to remain restrictive, although politicians have accepted the fact that they will miss budget deficit targets this year due to economic conditions. Monetary policy in advanced economies remains strongly expansionary. The central banks in the USA and Japan have announced plans to leave interest rates at their currently low level and to continue to implement quantitative easing measures until the economy stages a clear recovery. The institutes expect the world economy to pick up somewhat this year and in The economy should revive slowly in the euro area too. The rise in world output looks set to increase by around 2½% in 2013 and 3% in The downside risks, however, are considerable. One of the central assumptions underlying this forecast is that the crisis in the euro area does not intensify again. There are no guarantees, however, that reforms will be rigorously and successfully implemented in the crisis-afflicted countries. Should there be a noticeable slowdown, or even a failure in the structural adjustment processes in the crisis states of the euro area, a clear fall in confidence could result that would heavily burden the economy. An upwards trend re-emerged in the German economy in spring The business climate among German companies has improved significantly since last autumn. This is not least due to the fact that the situation in the financial markets has eased due to subsiding uncertainty regarding the future of European Monetary Union. The headwind in the world economy has also died down, with signals of a slight acceleration in growth outside the euro area. The business climate swing, however, has hardly affected order intakes or industrial production to date. Hard indicators in particular show no sign of a strong recovery in production in the first quarter of this year. Weather related influences also played a part in curbing activity in February and March. 3

4 Key Forecast Figures for the Federal Republic of Germany Gross domestic product (GDP) (% change on previous year) Employment a) (1,000 persons) Unemployment (1,000 persons) Unemployment rate b) (in %) Consumer prices c) (% change versus previous year) Unit labour costs d) (% change versus previous year) General government financial balance e) in EUR billion as % of GDP Balance of Current Accounts in EUR billion as % of nominal GDP a) Nationally. b) Unemployed as % of civil working population (definition according to the Federal Employment Agency). c) Consumer price index (2010 = 100). d) National employed compensation per worker in relation to real domestic product per working hour. e) e) compiled on a national accounts basis (ESA 1995). Sources: Federal Statistical Office, Federal Employment Agency, German Bundesbank; 2013 and 2014: forecast of the Institutes. JF Spring 2013 The institutes expect the economy to pick up over the course of this year. Moreover, concerns related to elections in Italy and the banking crisis in Cyprus show that a risk of the crisis intensifying remains, although it is not as great as last year. Conditions are ripe for a sharp increase in economic output. Interest rates are low and the conditions for obtaining credit are favourable. Moreover, German companies are highly competitive in the global market and have a strong presence in the high-growth developing countries of Asia. In addition, the labour market in Germany remains robust. There are virtually no traces of the recent economic downturn in this market. This means that income expectations remain stable, which should support consumer spending. Over the course of this year the increase in external demand is expected to accelerate gradually. This should improve the sales outlook for companies, meaning that they will become less and less cautious about making investments. Barring special factors such as weather-related constraints, the pace of the economic recovery in 2013 should pick up. However, annual average gross domestic product will only increase by 0.8% due to a statistical overhang, whereby the 68%-projection interval ranges from 0.1% to 1.5%. Imports look set to increase somewhat more quickly than exports.hence domestic demand will account for all of the increase in gross domestic product. Given the relatively high growth rate the situation in the labour market should continue to improve. 4

5 Employment will increase and the number of unemployed will total just 2.9 million on annual average. The upsurge in prices subsided recently, with a fall in the price of crude oil products. This is one reason why the inflation rate of 1.7% should be somewhat lower than in The public budget is expected to be almost balanced this year after a slight surplus last year. In 2014 the economy should pick up slightly. Capacity rate utilization will increase. Impulses should come from exports, which will increase at a slightly faster pace given the forecast improvement in the economies of trade partners. Ultimately, however, the domestic economy will be decisive in the upturn. This should provide a fresh impetus for investments. Residential construction in particular stands to benefit from low interest rates. Consumer spending should grow somewhat more strongly than in 2013, supported by a clear rise in disposable income. Overall, gross domestic product in 2014 is forecast to grow by 1.9%. The number of unemployed should decrease significantly to an annual average of 2.7 million persons. With the rise in capacity utilization, the inflation rate should increase to 2.0%. The public budget situation will continue to improve and the state should post a surplus of 0.5% related to gross domestic product, mainly thanks to more favourable economic conditions. Uncertainty hangs over this forecast due to the Bundestag elections that are scheduled to take place in September The conditions for the German economy have been so stimulating for some time that the increase in gross domestic product may even be higher than our forecast. The improvement in the business climate indicators since last autumn would also seem to point in this direction. However, a slight deterioration of the business climate in March, and not only in Germany, but also amongst its key trade partners, nevertheless sounds a note of caution. The data on new orders and industrial production do not point to any breakthrough yet either. Apart from uncertainty about the current basic business cycle tendency in the economy, the institutes believe that downside risks also prevail at the moment. Although structural adjustment processes have begun in the crisis-afflicted countries, some governments face major difficulties in implementing reforms. Any waning in the policies of consolidation and structural reforms may result in renewed turbulence. In the worldwide financial crisis and the European debt and confidence crisis economic policy has bought time with all types of monetary and financial policy measures. These measures made it possible to stabilize the situation in public finances and the labour market for the time being. In Germany the situation in public finances and the labour market is even very favourable at present. However, this should not mask the fact that the key problems that caused the crisis have yet to be solved,and that important steps 5

6 still need to be taken. The focus of economic policy should shift more towards longterm economic development. The European banking union is a central aspect of this development. The question of how a more stable banking system can be created in the future should be the main issue in designing any such union, and not how the burdens arising from the current system can be distributed. It is crucial that the unity of decision-taking and liability, which is central to a market economy, is restored. This particularly means that owners and creditors bear the costs in the case of a crisis, before taxpayers have to step in. The bail-in of bank creditors in the case of Cyprus was the result of a partially chaotic process. Events in Cyprus point to the need to implement predictable and credible rules governing reactions to banks and states in the euro area that run into problems. Such rules could also help to break the vicious circle of banking problems and sustainability issues related to public debt. The federal government points to budget consolidation successes. On closer examination, however, our assessment of the situation is chequered. On the one hand, the current over-fulfilment of the debt brake by the federal government can be attributed to factors that are not sustainable; key factors were low interest rates and cold progression. On the other hand, demographic ageing can already clearly be seen as a major challenge to public finances today. Efficiency considerations in budget consolidation, but also in other policy areas, are currently falling out of sight. In the budget consolidation no qualitative priorities were set. Additional revenues arising from cold progression were partly used to increase consumptive state spending and subsidies. Moreover, the introduction of a universal minimum wage is currently being discussed. The conflict between the goals of allocative efficiency and distribution targets should be clearly addressed in the political debate over this proposal. The turnaround in energy policy will also have effects on production potential. It will lead to a change in relative prices and a write-down of parts of the capital stock. The last point, in particular, is not being paid enough attention in the public debate. In Germany precautionary measures should also be taken to ensure that undesirable developments similar to those in some of the crisis-afflicted countries do not occur. In the years ahead, in which the single European monetary policy should have a clearly expansionary effect in Germany, this means pursuing a policy of fiscal prudence in the public sector on the one hand, and monitoring trends in private credit and debt on the 6

7 other, countering any potentiallyundesirable developments with macro-prudential instruments among others. 7

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