Joint Economic Forecast Spring 2010

Members of the Project team "Joint Economic Forecast":

ifo Institut für Wirtschaftsforschung an der Universität München
in collaboration with:
KOF Konjunkturforschungsstelle der ETH Zürich

Institut für Weltwirtschaft an der Universität Kiel

Institut für Wirtschaftsforschung Halle
in collaboration with:
Institut für Makroökonomie und Konjunkturforschung in der Hans-Böckler-Stiftung und
Österreichisches Institut für Wirtschaftsforschung

Rheinisch-Westfälisches Institut für Wirtschaftsforschung
medium-term forecast in collaboration with:
Institut für Höhere Studien Wien

Summary

In spring 2010 the recovery of the world economy is progressing; the financial and economic crisis of 2008 and 2009 is gradually being overcome. However, the pace of expansion is very different in the individual regions of the world. In some newly industrialised countries, particularly in Asia, the pace is exceptionally fast, and there is even danger of overheating in some economies. On the other hand, the utilisation of overall economic capacities remains low in the industrialised countries. Here the recovery has not yet been consolidated but continues to be supported considerably by expansive economic policies.

The relatively early and robust recovery of production and demand in the newly industrialised countries of Asia provided a noticeable impetus for the industrialised countries, whose real net exports thus rose significantly. Even though a collapse in output also occurred in the newly industrialized countries in autumn 2008, which was considerably powerful in some instances, it is now evident that the effects of the financial crisis have not changed the medium-term growth path very much because of mostly sound financial sectors and a generally favourable macroeconomic environment in the newly industrialized countries. In this respect we indeed can speak of a decoupling of important newly industrialised countries from developments in the industrialised countries.

The aftermath of the financial crisis is still being felt in the industrialised countries. The situation on the financial markets in Europe and in the United States, which had eased significantly in the summer half year of 2009, has not improved much since then; at the moment appreciable stimulation is not coming from this side. Moreover, the financial markets are becoming increasingly worried about national finances. Although the financial investors currently only see considerable insolvency risks for individual, mostly smaller countries, state indebtedness is presently increasing strongly almost everywhere, and hence economic policy in the industrialised countries must be geared in the medium term towards budget consolidation. The results of the financial crisis will still dampen the spending propensity of private households and businesses for some time, especially in countries where the financial and real-estate sectors are experiencing a structural crisis. But also in countries like Japan or Germany that were affected particularly by the collapse in exports, production is likely to recover only slowly from the strong setbacks suffered in the course of the crisis.

As a result the economic dynamics in the industrialised countries are expected to be weak in this and in the coming year. With a restrained economic expansion, the situation on the labour market will improve only gradually. In the United States economic activity will trend upwards in the forecast period, but economic growth will slow down perceptibly, after the strong expansion in the second half of last year. The euro area will be a cyclical latecomer also in this and in the coming year; some countries in which the desolate situation of the public budgets is forcing governments to pursue a strict consolidation course will even remain in recession. In contrast, the economic expansion in the newly industrialised countries is likely to remain strong. All in all world economic output in 2010 will grow by 2.9% and by 2.7% in 2011. World trade will increase by 6½% in this and in the coming year, a pace that matches its long-term average. The price climate should remain quite calm, even though inflation rates in 2010 will be higher than in 2009 due to increased oil prices.

In Germany the economic recovery stalled temporarily in the winter half year 2009/2010, because of largely passing factors. In its basic tendency, economic activity will continue to be directed upwards, after the deep plunge owing to the financial crisis. New orders increased strongly at the beginning of the year, and exports continue to recover. Business confidence is also strong. The now more favourable atmosphere is evident in the fact that businesses despite the recent weaker output are already slightly expanding personnel levels.

Economic policy is expected to have a countervailing impact on economic activity in the forecast period. The ECB will retain its expansive interest-rate policy, in the opinion of the institutes, and will concentrate for the time being on reversing its extraordinary measures of liquidity provision. Fiscal policy, on the other hand, will continue to provide perceptible stimulation to the economy this year. However, since the stimulus programmes are running out and initial steps towards consolidation of the national budget are expected, fiscal policy will have a dampening effect as of next year.

Against this background the institutes expect that the revival of economic activity will continue, but that its pace will be moderate. The recovery will continue to be driven by exports, which had experienced an unexpectedly strong collapse in the recession. Exports will profit from lively expansion particularly in the newly industrialised countries, but also domestic demand will revive. Private consumption spending should grow moderately with again rising real disposable income, and equipment investments will return to a steady course. All in all, real GDP should increase in the course of this year and on average for 2010 by 1.5%. In the coming year, the domestic demand will grow moderately. Real GDP will increase in 2011 by an annual average of 1.4%.

Since the beginning of the recession the labour market has been amazingly robust. This unexpectedly favourable development is largely the result of two effects. Firstly, the companies have been hoarding considerable numbers of workers, with help from government support for short-time working schemes and the more flexible provisions of collective wage contracts. Secondly, the labour market is still profiting from the mostly moderate wage agreements of recent years. Employment is expected to fall only slightly this year.

Unemployment will nevertheless decrease slightly, since the labour force potential is declining as a result of demographic developments. For 2011 stagnation in employment and a further decrease of unemployment is anticipated. The unemployment rate (in the delimitation of the Federal Employment Agency) should fall from 8.1% in 2010 to 7.9% in 2011. Consumer prices will increase only moderately – the inflation rate this year will be 0.9% and in the coming year 1.0%.

The situation of the public budgets will continue to deteriorate. The deficit rate in 2010 is expected to rise to 4.9%. In the coming year, a decline to 4.2% is foreseen, especially since the economic stimulus programmes are running out and initial measures for budget consolidation will be undertaken.

The risks for economic activity remain great, partly because of the international economic environment. Moreover, the situation in the banking sector remains difficult even though credit restrictions have not further intensified. However, problems could emerge again on the financial markets, for example if doubts arise regarding the solvency of some states due to their high deficits.

As a result of the economic crisis, the medium-term outlook for the German economy has also worsened; GDP in the coming years will be perceptibly lower than assumed before the crisis. Firstly, the production potential in Germany is presumably lower than previously estimated; secondly, production will return to its trend only slowly. The institutes expect that the production potential in the period 2009 to 2014 will increase by 1% a year. The economic recovery in Germany should continue after 2011 at a slightly accelerated pace. Nevertheless, after the strong collapse last year, real GDP will not reach the level of 2008 until 2013. At the end of the projection horizon, the gap between current production and the production potential will be closed.

Fiscal policy in Germany will likely set off on a consolidation course in 2011. Presumably, the economic situation will be solid enough that the recovery will not be damaged by government savings policies to such an extent as to bring about a relapse into recession. Criticism is to be directed at the federal government, despite its goals and its own proclamations, for not stating how it will go about budget consolidation. It does not intend to make these plans public until June this year.

To limit the damage of consolidation on growth and employment, the institutes have repeatedly recommended that the government pursue a “qualified” consolidation course, i.e. to narrowly limit the increase in government expenditures and to shift them to investments in human and physical capital. Savings should thus be concentrated on so-called consumptive costs and on financial assistance. In addition, tax concessions should be cut back.

The ECB enjoys a high confidence rating. Also for this reason, its expansive course has not led to a rise in inflation expectations; these are still closely anchored on the ECB’s stability goal. Since capacity utilisation will remain low in the forecast period, no dangers to inflation threaten from this side. The institutes expect that the ECB will keep its key lending rates unchanged during forecast period.

The current situation in the euro area illustrates the need for economic-policy action in especially three areas. Firstly, the key for the reduction of deficits on current account rests in the deficit countries, especially since, at least in Spain and in Greece, the balances of trade, also vis-à-vis countries outside of the euro area, have clearly deteriorated. The deficit countries must increase their price competitiveness in order to increase their exports or to substitute their imports.

Secondly, with regard to the solution of the financial problems of individual countries, the institutes are of the opinion that the IMF should assume an important role. It can threaten more credibly than EU institutions that there will be no financial assistance if states do not observe its stipulations and it also has more experience with the organisation of national rescue programmes. However, if the IMF becomes involved, it must be assured that the independence of the monetary policies in the euro area is not jeopardised because of financial assistance for a member state or by corresponding stipulations of the IMF. This is how the statements of the European Council of 25 March 2010 and of the countries of the countries of the euro area of 11 April 2010 are to be understood. These statements have tentatively promised, as the ultima ratio in case the Greek national budget cannot be financed by the capital markets, a package of credits from the IMF and coordinated bilateral credits from the member states. However, such assistance contradicts the spirit of the Maastricht Treaty. In order not to further damage the effectiveness of the monetary union, the institutes strongly recommend that the IMF supervise the conditionality called for in the statements and the associated decisions on releasing further tranches. Moreover, this must not lead to the inception of a “transfer union”.

Thirdly, it is a matter of complying with the system of rules of the monetary union, since the current problems are also a result of the fact that many countries have not complied with the stipulations of the Stability and Growth Pact in recent years. Over the years it has became clear that the European Commission is not able to enforce compliance with the rules. For this reason the institutes welcome the statement of the European Council of 25 March 2010 calling for a strengthening of the European system of rules.