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Domestic demand driving German economy

Press Release of December 17, 2015

DIW Berlin’s economic forecast: GDP growth will remain stable over the next two years – domestic economy benefiting from favorable labor market situation and expenditure on asylum seekers – public sector has surpluses, but margins are tightening

The German economy is expected to continue in its upward growth over the next two years: According to the latest economic forecasts from the German Institute for Economic Research (DIW Berlin), the GDP is expected to grow by 1.7 percent in the current year, as well as in 2016. In 2017, growth is expected to be slightly lower, at 1.5 percent—but only because there are fewer working days due to the timing of public holidays.

IN SHORT

Marcel Fratzscher (President of DIW Berlin): “Over the next two years, public spending for refugees will act as a massive stimulus program—similar to that of the global financial crisis of 2009 and 2010. Without the stimulus caused by expenditures on asylum seekers—which amounts to 15 to 17 billion euros annually, or 0.5 percent of GDP — economic growth in 2016 and 2017 would be significantly lower. The German economy’s greatest weakness is the low public and private investment, which is still close to its historic lows despite dynamic consumer demand. Policy must not lose sight of the urgent need to improve the conditions for investment.”

Ferdinand Fichtner (Head of the Department of Forecasting and Economic Policy): “Things are looking up again somewhat for the global economy. One bit of good news is that China is being transitioning to a more consumer-driven economy without experiencing any major economic downturns so far. Overall, emerging countries such as Russia continue to suffer because they currently have to sell energy—primarily oil—at prices that are significantly lower than they have been in the past, and because inflations rates are high in many places. In addition, the upcoming U.S. interest rate turnaround could lead to capital outflows and further upheavals. The growth rates we have seen in recent years are thus no longer in the cards for the time being.”

Simon Junker (Deputy Head of the Department of Forecasting and Economic Policy and an expert on the German economy): “Private consumption is currently the main growth driver for the German economy. This is connected firstly to the good labor market development—but this year, the boost in purchasing power due to low energy prices has also been pushing consumption. In the coming year, especially, the growing number of asylum seekers is expected to lead to noticeable demand stimulus. If we exclude these special factors, however, it appears that the things are less favorable than they seem: When measured in terms of economic performance over the past few years, consumption is still too weak—in fact, it would need to be strengthened more sustainably.”

Kristina van Deuverden (Research Associate in the Department of Forecasting and Economic Policy and an expert on finance): “Public finances—that is, the coffers of the federal government, the Länder, the municipalities and, and the social securities —will also conclude the next two years at a surplus. However, the margins are narrowing: Given the high number of refugees, many financially weak communities are already reaching their limits. Because the federal government has promised municipalities aid at different points, the federal budget might slip into the red in 2017. But in general, the German state can shoulder the problems associated with the current development of financial burdens. As well, the much-needed growth-enhancing measures must not be abandoned.”

Domestic demand is the primary growth driver of the German economy. Private consumption is having a powerful influence on growth; however, this is linked in part to special factors, such as the sharp drop in oil prices. As well, government expenditure on asylum seekers—including spending for transfer benefits and language courses—increases, which is reflected in the aggregate of private consumption. Apart from these special factors, the dynamic of private consumption is not very strong. The construction industry is also benefiting from the demand triggered by the migration, because new housing is urgently needed in many cities.

DIW Berlin predicts, based on various assumptions—for instance, about the number of asylum seekers, the processing time of applications, the acceptance rate, and the unemployment rate—that the gross government expenditure in connection with the asylum seekers will stand at just under 6 billion euros this year, and in the next two years, at just under 15 billion and 17 billion euros, respectively. This expenditure will face additional revenue—which is even more difficult to quantify—such as VAT, payroll tax or social security contributions. On balance, public finances are expected to conclude the next few years at a surplus, although this will lessen over time. (See also the current press release on Fiscal Policy.)

Global economic prospects are brightening, but still not rosy

The global economic situation will likely improve somewhat during the forecast period. In Russia and Brazil, the contraction of economic output is weaker than before, and a hard landing of the Chinese economy didn’t materialize so far. Moreover, in the U.S. and the UK, economic development is strong. Overall, DIW Berlin’s experts expect a growth rate of 3.4 percent this year, 3.6 percent in 2016, and 3.9 percent in 2017. The development, however, is not without risk: High inflation and the imminent U.S. interest rate reversal could burden the economy in the emerging countries more significantly than had been assumed. Add to this the low commodity prices, which are making things difficult for the oil-exporting countries in particular. Even if the low energy costs offer opportunities elsewhere, since the production costs are sinking, the emerging countries’ economies are unlikely to return to the growth rates of past years.

In this environment, the euro area will see only moderate growth. Due to weaker demand from China, Russia, and Brazil, exports have been developing moderately—even though the weaker euro fundamentally supports foreign trade. The upswing will mainly be supported by private consumption—especially because the unemployment rate is sinking in many countries, and disposable incomes are increasing, also because of the low inflation rates. In contrast, the minor price acceleration should complicate the necessary deleveraging process: In many countries, it is not only the public sector that is dealing with high debts—households and corporations also need to straighten out their balance sheets. All in all, growth should lie at 1.5 percent in 2015 and 2016. In 2017, a somewhat higher increase in GDP is likely.

Net exports don’t contribute to German economic growth in 2016 and 2017

In Germany, economic output will grow at a slightly above-average rate in the upcoming quarters. Corporations, however, will continue to be reserved with investment, not least because of existing uncertainties about the global economic development and the orientation of the euro area and the EU. The primary growth driver is currently private consumption, which also received a boost this year from the lower energy prices. The labor market situation remains favorable, however: The number of employed individuals will increase over the next two years to new record highs, expanding the payroll by roughly four percent per year. However, the unemployment rate will also increase, because of the marked growth of the labor force, also due to more recognized asylum seekers entering the labor market. The unemployment rate will stand at 6.4 percent this year, 6.5 percent in 2016, and likely at 6.8 percent in 2017. The overall strong domestic economy ensures that imports are growing faster than exports. Although exports are still doing well, net exports will probably no longer be contributing the growth of the economy over the next two years.

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