German economy is on a moderate growth path, but effects from the crisis still remain

Press Release of April 14, 2010

DIW President, Klaus F. Zimmermann: „Fiscal consolidation is on top of the agenda.”

The German economy is expected to show moderate growth for 2010 and 2011. According to the DIW economic outlook, GDP will increase by 1.7 in 2010 and by 1.8 percent in 2011. “We recover from the crisis. However, with respect to financial markets, high uncertainties remain.” said DIW President, Klaus F. Zimmermann. After the acute crisis management, economic policy has to move back to a more sustainable path: “The biggest challenge will be related to the consolidation of public finances, as the burden of debt has risen enormously.”

High risk premiums on European government bonds: Should the policy intervene to correct financial markets?

Since the outbreak of the crisis one could observe a steep increase in the interest rate spreads of some European government bonds compared to bonds issued by safe haven countries such as Germany and the US. While the interest spreads hardly exceeded  50 basis points before the crisis, European countries have had to accept considerable risk premia since then.
The increase of risk premia can be partially explained by a general increase in the risk aversion of international investors. Because of the financial crisis, European governments have to pay a surcharge compared to safe-haven countries such as Germany and the US irrespectively of their economic policies. The degree of risk aversion has generally increased because of the crisis.
Besides this effect, the individual country situation is also relevant. On average, one-third of the spreads are home-made. In some countries, the specific problems have a higher weight. Hence, financial markets play an important disciplining role to promote budgetary consolidation. Policy actions directed to support the Greek government should not limit this role.

The stimulus in Germany in 2010 is primarily attributed to the recovery of the global economy. In the year to come, domestic demand will be the main driver of growth. As in former times, Germany will benefit from higher world trade, but less than initially expected. The main markets for German exporters do not coincide with the current power centers of the world economy, which are located both in Asia and South America. German exports are mainly delivered to the euro area and Eastern Europe – the recovery for these markets is still weak.

Europe will be affected from the global recovery with a delay

After the unprecedented recession, the global economy is on its way to recovery. Global trade has stabilized and even expanded during the recent months. However, the development will be very heterogeneous across the regions. Hence, the decoupling of national business cycles is back on the agenda. While countries in Asia and South America show high growth rates, industrial countries will experience only a moderate upturn. Even for the emerging markets, the outlook is not uniform. Growth in the Central Eastern European countries and in Russia will be below the average. “However, new growth centers such as China and India cannot significantly stimulate the economic recovery in the industrial countries” according to the assessment of Dr. Christian Dreger, head of the macroanalysis and forecasting department. For example, China and India absorb only 10 percent of the exports of industrial countries.

The German job market is expected to stabilize at a high level: The unemployment rate will stay below 8 percent in both years of the forecasting horizon. „Despite the huge losses in production due to the financial crisis, the labour market has proven to be very robust,” said DIW labour market expert, Karl Brenke. „and we do not expect a deterioration.” The reason for the favorable labor market is that the effects of the crisis have been essentially limited to the export industry. Moreover, firms avoided excessive lay offs by temporarily reducing working hours. However, even though economic growth will be above the employment threshold, it will not be sufficient for an increase in employment, .

Fiscal revenues will be even lower than previously feared

Public revenues are expected to develop even worse than predicted just a few months ago. For example, DIW Berlin expects 2010 reduced receipts from the wage tax bill of seven billion Euros: In the first months of 2010, wage tax revenues fell dramatically. Factors behind this development are the so-called growth acceleration law and the lower wage increases. “The situation of public finances is desolate,” said DIW President Zimmermann. “Therefore, there is no room for lowering taxes. To consolidate public sector budgets, tax increases might be even necessary.”

No inflation pressures in the short run

Consumer prices have risen slightly over the recent months. The development is mainly driven by an increase of energy and food prices. We expect only moderate rates of inflation of roughly 1 percent for the period ahead. Capacity utilization is still at low levels, and wage negotiations will not exert any significant inflation pressure. In the medium term, however, inflation could become more relevant. Given the stance of public finances in industrial countries, policymakers could try to lower real debt by increasing inflation. However, higher inflation targets are not the appropriate strategy to deal with budget problems.