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German economy in an interim low

RWI Essen is sticking with its December 2007 estimate and continues to forecast real growth in gross domestic product (GDP) at 1.7% in 2008. The institute does indeed feel that the strong appreciation of the euro, rising prices for natural resources and less favorable loan terms for companies will slow the tempo of expansion. The German economy seems, however, to have entered the year with more momentum than previously assumed. Expansion is being hindered by ...

RWI Essen is sticking with its December 2007 estimate and continues to forecast real growth in gross domestic product (GDP) at 1.7% in 2008. The institute does indeed feel that the strong appreciation of the euro, rising prices for natural resources and less favorable loan terms for companies will slow the tempo of expansion. The German economy seems, however, to have entered the year with more momentum than previously assumed. Expansion is being hindered by a high inflation rate, estimated at 2.5% for 2008. RWI Essen is anticipating 1.8% growth in GDP for 2009. The unemployment rate next year will probably continue to decline, to 6.8%. The federal budget surplus then might well come to 0.3% of GDP.
This forecast operates on the assumption that the global economy this year will be more hesitant in its growth. World economic product, adjusted to account for inflation, should grow by 2.5% in 2008 and 2.9% in 2009. This translates into growth of 5.5% and 7%, respectively, for world trade. One thing must be kept in mind, however. Experience indicates that there is a far greater degree of uncertainty in forecasting in an unstable business climate such as the one at present. Thus the prognosis is based on the assumption that the situation on the financial markets settles and that the subprime crisis in the US subsides.

Business activity in Germany cooled somewhat toward the end of 2007, when the retarding effects deriving from the international situation had not yet come to bear. The primary factor was a surprising decline in private consumption. Companies, on the other hand, expanded their capital investments, doing so in part so as to take advantage of the more favorable depreciation rules in place in 2007. A noteworthy number of jobs was created. Employee's compensations rose once again. Purchasing power was, however, curbed by rising inflation. In November 2007, at 3.3%, it reached the highest value since 1993. Gross domestic product (GDP) increased by 2.5% when averaged over the year.

RWI Essen is expecting that the tempo of GDP expansion this year will decline and growth in exports and investments in particular will be weaker. Responsible for this will be above all the strong appreciation of the euro, the continuing rise in raw materials prices and in world market prices for industrial feedstocks and foods as well as the less favorable financing terms for firms. Overall income for private households, by contrast, should grow a bit more rapidly due to the higher employment rate and more distinct wage increases. In spite of increasing food and energy prices, one may expect expenditures for private consumption to expand this year, even though quite cautiously. Taking all this as the background, RWI Essen is anticipating GDP growth of 1.7% in 2008 and thus is holding to its forecast in December 2007. In 2009 GDP will most likely increase by 1.8% on average. Here it is assumed that the situation in the finance markets normalizes and that the subprime crisis in the US is brought to a conclusion. If these assumptions eventuate, then inflation should ease within the forecasting period. RWI Essen is looking at an inflation rate of 2.5% this year and 2.0% in the coming year.

The situation on the labor market will probably improve further. The unemployment rate - though favoured by demographic factors - should decline to 7.7% on average this year and 6.8% in 2009.

 

Even though fiscal policies in the meantime have clearly been turned toward an expansive course, the situation in government budget will tend to improve further during the forecasting period. Following last year's balanced budget, RWI Essen is expecting a deficit this year coming to 0.3% of GDP. It is expected that the budget will be in the black by 0.3% next year, due in part to the fact that hidden tax increases will boost tax revenues.

One risk found in the domestic economy is the high rate of inflation that has increased the hazard of a wage-price-spiral that in turn could fan inflation rates. The ECB here is on the horns of a dilemma. One of their tasks is to respond appropriately to the uncertainties in financial markets and the risks of a recession; that would favor dropping the interest rate. Another function, however, is to ensure price stability and that argues against decreasing those rates.

RWI Essen is for the first time submitting a medium-term projection for the period from 2008 to 2012 and is doing so parallel to unveiling the current business forecasts. This projection was worked out in collaboration with the Institute for Advanced Studies in Vienna. The estimate arrived at here is that the German economy will grow at a rate of 1.75% over the medium term. Contributing to this somewhat stronger growth trend than in recent years is that the volume of work - that expanded by only 0.2% annually in the years 2002 through 2007 - may now rise once again by 0.5% per year, particularly because the rise in the employment rate which has been observed recently can be expected to continue.

International business recovers in 2008 after a listless start

International business activity cooled down around the turn of the year 2007/08, particularly in the USA, where GDP rose hardly at all in the fourth quarter. In Japan GDP did indeed grow quite strongly toward the end of the year but preliminary indicators are pointing to a softening there, too. In the European countries the forces propelling the economy have been more tenacious. The Chinese economy once again registered double-digit growth toward the end of 2007.

In the first half of 2008 expansion in the industrialized countries will probably remain weak. As regards the USA, RWI Essen is expecting - following a sluggish first half year - gradual recovery in the second half. Some observers are in fact expecting that spiritless business activity in the US will be less of a burden than in the past. One of the factors coming to bear here is hefty expansion in the emerging economies. But those countries in particular are closely intertwined with the fates of the USA so that any weakening there will spill over to the other national economies after a certain delay, though the extent will vary by regions. World economic product - adjusted for price changes and weighted with the GDP in dollars - may rise by 2.5% this year and 2.9% in the coming year, following last year's growth of 3.2%. World trade will probably expand this year by 5.5% and in the coming year by 7%, this in comparison to a 6% rise in 2007.

Experience has shown that the uncertainties associated with forecasting are particularly large in an unstable business situation. It is by no means certain that the world's economy has in fact become more resistant to periods of economic weakness in the USA. This is all the more true since the turbulences in the financial markets have left their traces all over the world, the risk surcharges are rising everywhere, and the banks in many countries have become much more restrictive in granting credit.

(Published in "RWI : Konjunkturberichte", Volume 1/2008), German version

For further information, please contact:
Dr. Roland Döhrn, Phone:+49 201 8149-262, e-mail
Sabine Weiler (Press Office), Phone: +49 201 8149-213, e-mail