The RWI considerably lowered its economic growth forecast for Germany in 2009 to -4.3%. A slight upward trend, at 0.5%, is expected for 2010. Contrary to the hopes of some, the financial crisis is thus having a stronger impact on Germany than on most other eurozone countries. Despite significantly greater numbers of employees being placed on part-time schedules, the number of employed is expected to drop by about 1.2 million in the course of the year as unemployment increases by 1.1 million.

The German economy is currently experiencing a deep recession. Within the final quarter of 2008 the real gross domestic product (GDP) shrunk by 2.1% relative to the third quarter. The decrease resulted mainly from dwindling net exports, which at -7.3% declined twice as strongly as imports. Domestic spending decreased only slightly, since many businesses sought to soften the blow of falling demand by increasing stock levels. Investments in equipment, on the other hand, dropped considerably. The financial crisis is thus having a stronger impact on Germany than on most other eurozone countries.

Current indicators suggest that GDP will decrease again sharply in the first quarter. As this trend continues, the drop in GDP is forecast to decline by 4.3% in 2009, amounting to the greatest decrease in German history. The decline would be even more dramatic, were it not for the countertrend, which we believer likely in the second quarter of 2009, as parts of the stimulus package temporarily generate domestic demand. In addition, the recent production decline was probably exaggerated by companies temporarily closing down for longer than necessary.

The drop in inflation, driven mainly by falling prices for raw materials, should stimulate the economy as well. After 2.6% in 2008, the average inflation rate in 2009 is expected to be a mere 0.4%. This will reinforce consumer purchasing power. Added to this is an increase among a number of transfer. Consumer demand is expected to be suppressed by the predicted drop in employment. While the number of employees working shorter hours should increase to a considerably higher level than in past recessions, we nevertheless expect about 1.2 million jobs to disappear in the course of the year, driving up unemployment by 1.1 million.

Past experience shows economic crises originating in the banking sector to be particularly adamant and long-lasting. Yet, once the financial market situation settles down, there is a good chance of gradual economic recovery in the course of 2010. Among other reasons, the stimulus programs launched by a great number of countries should take effect on the global economy. There may be an upsurge in investments, too, if businesses take advantage of the more favorable write-off requirements in effect until the end of 2010. In sum, we expect GDP to be 0.5% higher in 2010 than in 2009.

Appropriate response in economic policy

The goal of economic policy is to stabilize both the financial markets and the economy in order to prevent a downward spiral. Currently, an expansive financial policy would be very appropriate, considering the risk of monetary policy not being as effective as usual due to the difficulties in the banking sector. Financial policy in Germany is providing a strong stimulus. For this reason we expect the second stimulus package (Konjunkturpaket II) to slow down the decrease in GDP by only 0.5% in this year and by 0.3% in 2010.

As a result of the two stimulus packages in addition to other discretionary measures, yet also due to automatic stabilizing factors, we expect a deficit increase to 3.5% in the current year and 4.7% in the coming one. This will limit the options for responding through financial policy. Policymakers therefore need to ensure that public debt does not continue to increase once the crisis is over and to then refocus on budget consolidation. The proposed brake on spending is a step in the right direction, even if it must prove itself in the course of budget implementation.

Global economic situation

As in Germany, the economic slump has taken hold of almost every country worldwide. Export-dependent economies have been particularly hard-hit, including Japan, the emerging countries of Asia and Eastern Europe, in addition to Germany. Economic performance is deteriorating at the same rate almost everywhere, so that no diversification of risks is possible among different countries and markets.

This has additionally led to a noticeable decrease in demand for raw materials, resulting in drastic price drops. Taken by itself, this has had a stabilizing effect on countries importing raw materials by causing inflation to fall considerably. Yet the price drop has simultaneously aggravated problems in the countries which export raw materials. On the whole, this effect has probably even suppressed the global economy somewhat.

While monetary policymakers in most countries have lowered key interest rates considerably, this instrument does not appear to be having its usual effect of contributing to a more stable economy, as the banking sector is still not functioning properly. In this exceptional situation, most countries are justified in pursuing a highly expansive course in financial policy.

In spite of this, it is hardly likely that the production slump will come to an end very soon. We assume that overall economic production will continue to decline in most countries until the end of 2009. On the other hand, the downward spiral driven by cautious investment policy and falling imports should gradually come to a halt in the course of the year, assuming that the situation on financial markets stabilizes. On a yearly average, we expect a strong decrease of 2.6% in global GDP. The global economy will probably recover only gradually in the following year, with growth remaining weak at 1%.

There continues to be considerable risk of more serious recession. The deeper the slump and the longer it continues, the greater the likelihood of changed patterns of behavior, triggering even deeper repercussions of the crisis. There is a chance of global economic problems worsening if, in the face of highly underutilized capacities, a deflation trend unexpectedly takes hold. Additionally, an enormous risk exists of certain countries introducing protectionist policies. World trade could further decline, resulting in an even more serious global economic crisis.

(published in "RWI : Konjunkturberichte", Heft 1/2009) (available only in German)

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