Press Release of October 9, 2014
The German economy will grow by 1.3 percent this year and by 1.2 percent in 2015, predict the economic research institutes involved in the Joint Economic Forecast in their autumn report. According to the report, Germany’s economy has cooled down markedly. With economic output falling in the second quarter and stagnating in the third quarter of 2014, the engine for economic growth is proving hard to rev up again. Both domestic and foreign demand is weak: the consumer climate deteriorated recently and companies remain cautious about investment. The moderate pace of growth in the world economy and the low level of economic impetus in the euro area over the forecasting period are also having a negative impact. In this environment the economic research institutes are in favour of strengthening growth and creating more favourable investment conditions. They see financial scope for a more investment-friendly tax system and higher spending on areas that promote growth like physical and human capital.
World production continued to expand at a moderate pace in autumn 2014. The upturn continued in the USA and Great Britain, but contrary to expectations in the spring, a recovery did not take hold in the euro area. Economic activity is heterogenous in the emerging economies, with China slightly losing pace. Fairly weak world economic expansion was reflected in minimal growth in world trade during the first half of 2014.
Monetary policy orientation in the advanced economies started to differ in 2014 in line with the different business cycle situations. In the USA the main refinancing rate still remains close to zero percent, but it will be raised in spring 2015 if the economic recovery continues. The European Central Bank (ECB), by contrast, dropped its main refinancing rate to 0.05 percent in September and its deposit rate to -0.2 percent. The implementation of targeted, longer-term refinancing operations and the purchasing programmes for covered bonds and asset-backed securities will provide little stimulus for the euro area’s economy.
During the forecasting period fiscal policy will remain restrictive in most advanced economies, yet the degree of restriction will continue to ease. Hardly any consolidation is still taking place in the USA. The institutes assume that consolidation efforts in many euro area countries will continue to lag behind what has been negotiated in the respective stability programmes, although interest rates on government bonds are low, which reduces the interest burden.
The pace of world economic expansion will remain moderate in the forecasting period. The upturn in the USA will continue. It will be supported in particular by monetary and fiscal policy, a gradual recovery in the labour market and lower debt levels of private households. Economic impetus in the euro area will remain weak. There are no signs of the long-waited recovery yet, and forecasts have been gradually downwardly adjusted accordingly. Since the world economy is only gradually gaining pace, no major impulses are expected from exports. The conflict involving Russia has further clouded over the economic outlook and will weigh on corporate investment activity.
Companies are also still targeting higher equity ratios; while private households are trying to improve their asset positions. This will dampen demand – although to a declining degree – until the end of the forecast period. There are however, a number of supportive factors: fiscal policy is expected to be far less restrictive than in previous years, and structural deficits will fall more slowly. Asset prices are rising again in many countries and labour markets are stabilising, while exports are benefitting from the lower Euro exchange rate. In those emerging economies that export commodities the outlook remains bleak, since commodity prices are barely expected to rise due to the moderate increase in world industrial production. The growth rate will remain high in China, although rates are expected to decline gradually. Yet, there is the risk of a sudden slump, especially in the real-estate sector, which is particularly important in China, and which has been heated in recent years by excessively high credit expansion. All in all, the institutes expect world production to increase by 2.6 percent in 2014 and by 3 percent in 2015.
The risks to the world economy are significant. This is due to the problems in China’s real-estate market, but also to Russia’s conflict with the West. Moreover, even greater risks may hide in the balance sheets of the euro area’s banks. The ECB’s scrutiny of the quality of the banks’ assets should provide more details on that score. If legacy issues on the bank balance sheets are not swiftly dealt with, supply-side credit restrictions will continue to exist in several countries of the euro area, which will have a dampening effect on the economy in the longer-term. The weaker price dynamic in the euro area also points to risks. The surprisingly low inflation means that the real burden of old debts is higher than expected. The real financing costs of households and companies will also rise if the nominal interest rates do not fall in line with inflation due to the zero interest cap that has already been reached in the euro area. For the euro area overall, however, no deflation scenario is to be reckoned with at present, as long as there are no signs that mid to long-term inflation expectations are taking off.
The German economy has cooled down. After a strong start to the year, production in the second quarter of 2014 fell by 0.2 percent compared to the previous quarter. The buoyant dynamic at the start of the year due to an unusually mild winter was not expected to last, but the downturn in production was nevertheless unexpected.
Favourable financing conditions, rising capacity utilisation and the confidence expressed in business surveys seemed to suggest that investment would accelerate.
However, an upturn in investment did not occur. On the contrary, the economy has clouded over since the spring. This is reflected in the Ifo Business Climate, which has deteriorated for five consecutive months since May. Several factors contributed to this deterioration: world economic production expanded at an unexpectedly moderate pace and the euro area’s economy, in particular, remains in a weak phase. The economic outlook also deteriorated due to international crises like the simmering Russia-Ukraine conflict and the military conflicts in Syria and Iraq. Moreover, German domestic demand is showing clear signs of weakness. Private consumer spending rose only slightly in the second quarter and the consumer climate deteriorated in recent months. Consequently, corporate investment fell in the second quarter and there is hardly any evidence to suggest that this cautious approach to investment will change in the near future.
Against this background, the economic outlook for Germany remains subdued. Overall economic output is only expected to stagnate in the third quarter. Another drop is expected in industrial production. Leading indicators suggest that growth will remain weak until the end of the year. Accordingly, incoming orders were lower on average in the months of July and August than in the second quarter. All in all, GDP in 2014 is expected to rise by 1.3 percent. The 68 percent projection interval ranges from 1.1 percent to 1.5 percent. Stagnation in the second half of the year means that the capacity utilisation of the German economy will fall, and the output gap remains negative.
The first signs of a weak economy are appearing in the labour market: the increase in employment has slowed and registered unemployment recently rose slightly. The inflation rate is low. In September consumer prices were 0.8 percent above the previous year’s level, which was also partly due to external factors like the decline in energy prices. Consumer price inflation will be 1.0 percent in 2014.
The economic outlook is also subdued due to a headwind from economic policy. Although fiscal policy is providing expansive stimuli in terms of discretionary measures, the pension package and the introduction of a nationwide minimum wage are hampering growth. In addition, the German federal government is not making enough use of its financial scope to invest. All of these factors are having a negative impact on private willingness to invest. It is to be welcomed that the federal government sees fiscal consolidation as particularly important. However, in view of an expected fiscal surplus of 0.3 percent and 0.1 percent in relation to GDP for the years 2014 and 2015, it should certainly be possible to reduce the tax burden.
Monetary policy still aims to have a stimulating effect on the euro area economy. Interest rates in Germany are very low as a result. However, the measures recently agreed upon are not expected to provide hardly any additional stimuli for the real economy.
Despite slightly expansive fiscal policy and the fact that interest rates will remain low, the output gap will continue to be negative in the years ahead. The increase in production in 2015 will be lower than previously forecast. The institutes expected GDP to increase by 1.2 percent in 2015, which corresponds to a mere 1.0 percent increase when adjusted for calendar effects. The 68 percent projection interval ranges from -0.3 to 2.7 percent.
Exports will only increase haltingly and more slowly than imports, meaning that international trade will make a slightly negative contribution to overall economic expansion. The upturn in domestic demand will accelerate over the course of the year ahead, but corporate spending on equipment and building will only grow gradually due to the less favourable turnover outlook. In addition, despite having negative employment effects, the nationwide minimum wage will increase the total wage bill. However, it lowers company profits and, on balance, real aggregate demand will not be stimulated by the minimum wage since part of the higher costs created by the minimum wage will be passed on to prices. Consumer prices are expected to increase by 1.4 percent in 2015, of which 0.2 percentage points are due to the minimum wage.
The number of unemployed will rise slightly to 56,000 persons on annual average, while the unemployment rate will total 6.8 percent in 2015.
According to this forecast, the uptick in investment activity will be sluggish. For companies, the uncertain sales outlook and the headwind from economic policy appears to outweigh favourable financing conditions. Domestic demand in Germany appears too weak to offset the effects of the deteriorating international trade environment. These are results of the analysis of a Special Chapter that are presented at the end of this report.
In this environment, the main task of economic policy is to strengthen growth and create favourable conditions for investment activity. There is a certain scope for a proactive fiscal policy that will achieve these aims. On the income side this scope should be used to design investment and growth-friendly tax systems, especially via reducing the tax burden. On the expenditure side, public spending should be increased in areas that potentially boost growth – in other words on physical and human capital. However, funds should not be distributed evenly across Länder, as intended by standard Länder entitlements, but tailored to their specific needs and dictated by considerations of efficiency.