The world economy is currently at the beginning of an upswing. Output in the U.S. has started to recover even earlier than had been expected by the Institutes. In Western Europe, while the rise in production was still modest in the first months of the year, consumer confidence as well as business climate improved markedly. Also in the Asian NICs the cyclical bottom has been passed; Japan, by contrast, continued to be in recession.
Weekly Report/ Wochenbericht 17/2002
The cyclical turnaround was initiated by economic policies, particularly in the U.S. with the Fed being on an extraordinarily expansionary course and fiscal policy also being significantly stimulating. In Western Europe, monetary policy has also eased, if to a lesser extent than the U.S. counterpart. In the course of this year the stimulating economic policy effects will continue to unfold in the U.S. and in Western Europe and output will grow briskly. Next year in both regions the pace of growth will slightly decrease as impulses from economic policy will diminish. Real GDP in the industrial countries as a whole will rise by 2.8 percent in 2003, following only 1.2 percent in 2002.
In spring 2002, an upswing in the German economy is imminent. Confidence in the industrial sector has significantly increased in the past months. Especially, the external environment has strongly improved. Economic activity is further stimulated by expansionary monetary policy.
In the course of the upswing in the euro area monetary policy will be slightly tightened and the ECB will move to a more or less neutral course. The Institutes expect that wage increases will remain moderate in the forecast horizon; in 2002 and 2003 wages will probably rise by roughly 2 ½ % and thus somewhat faster than in the preceding two years. As regards fiscal policy substantial spending cuts are to be expected. The consolidation course will be intensified; according to the forecast the German government will undertake a savings package of around 8 billion euro in 2003.
In the wake of a strongly expanding world economy German exports will rise again. Moreover, the significant improvement of expectations in the U.S. and in Europe will spread to Germany and exert a positive effect on corporate investment. Private consumption will also increase again. In the further course of this year expansionary impulses from monetary policy will gradually build up. All in all, it is probable that the upswing will strengthen in the second half of this year.
In the coming year the speed of expansion will slow down. The impulses from abroad will weaken and the stimulating effects of monetary policy will gradually fade. Furthermore, fiscal consolidation will dampen economic activity. Real GDP in Germany will rise by 2.4 percent in 2003, following an increase by 0.9 percent this year. The situation on the labor market will improve; the number of unemployed persons will decline to 3.8 million in 2003 on average. Consumer price inflation remains moderate.
For all that, the forecast is subject to downside as well as upside risks. Cyclical developments in the U.S. constitute a factor of uncertainty; the expansion there could turn out weaker than expected. An oil price significantly higher than that assumed in this forecast could also dampen economic activity. Yet, it cannot be excluded that the pace of the upswing is underestimated. In view of the strongly improved corporate expectations cyclical dynamics could well be more vigorous than forecasted by the Institutes.
In spite of the mentioned risks the upswing in Germany does not seem to be especially endangered. In order to secure a sustainable upward trend it is now necessary that the individual areas of economic policy maintain their medium-term orientation. Monetary policy must primarily be intent on price level stability. It is important that wage policy supports the ECB in the achievement of the stability goal.
Much would be gained if it could be made credible that wage increases in the euro area remained compatible with stability in the years to come. If wage increases are lower than the sum of the medium-run rise in productivity and the inflation target then potential output growth will temporarily accelerate. Accordingly, the ECB could raise the reference value for M3 expansion. Yet, this does not mean that an ex-ante coordination between monetary policy and wage developments is desirable or necessary. Monetary policy must not make the first step and alter its policy due to the (uncertain) hope that wages will rise only very moderately.
Fiscal policy is facing a special challenge. In February, the federal government once more committed itself to a nearly balanced budget for the year 2004. This requires a fiscal consolidation program which may dampen output and employment growth in the following two years. Nevertheless, it is important that the government does not move away from its fiscal target; otherwise fiscal policy would continue to lose credibility. Fiscal consolidation should proceed on the expenditure side; far-reaching measures are necessary. Additional tax increases should be ruled out because they would harm economic growth. The expectation of a diminishing tax burden can best be promoted by a policy that sets a corresponding government spending path in advance and then implements it without reservations. Only if the government saves taxes can be cut.