Joint Economic Forecast Spring 2012

Members of the Project Group Joint Economic Forecast are:

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

Institut für Weltwirtschaft an der Universität Kiel
for the medium term economic forecast in cooperation with:
Zentrum für Europäische Wirtschaftsforschung (ZEW) Mannheim

Institut für Wirtschaftsforschung Halle
in cooperation with:
Kiel Economics

Rheinisch-Westfälisches Institut für Wirtschaftsforschung
in cooperation with:
Institut für Höhere Studien Wien

Summary

After a weak winter half year, the German economy is now experiencing an upswing. The Institutes forecast a 0.9% increase in real GDP for 2012 and a 2.0% increase for 2013. The situation in the employment market should continue to improve and the number of unemployed is expected to drop to 2.8 million in 2012. Germany’s deficit ratio is forecast to drop to 0.6%. Since its debt ratio remains very high at over 80%, the Institutes take a critical view of the current flagging in consolidation efforts. The debt and confidence crisis in the Eurozone continues to smoulder. Forecasts of the respective debt ratios of Italy, Ireland and Spain indicate that the situation in these countries can only be stabilized if planned reforms are actually implemented, and in the absence of any renewed loss of confidence on the part of the financial markets.

The acute risks for the global economy decreased significantly in spring 2012 versus last autumn. Confidence among business and consumers, which was knocked hard in the second half of 2011, has recovered in most regions since the beginning of 2012. The pace of world output has also picked up slightly in recent months, after clearly losing impetus during the second half of last year. The outlook for the global economy nevertheless remains subdued as the European debt crisis remains unresolved and continues to pose a major threat to the world economy. Additional negative factors have also come to bear recently like oil prices, which have soared in recent weeks. Moreover, the pace of economic growth in China and other emerging economies has slowed down too.

Despite the current upturn in confidence indicators, the Institutes do not expect a strong upswing in the world economy during the forecasting period due to the continued presence of a number of negative factors. Financial policy in many of the world’s key advanced economies, and especially in several Eurozone countries, is expected to have a dampening effect. Moreover, private households and business in many economies are still attempting to reduce their debts. However, the delayed effects of private debt reduction should gradually weaken over the forecasting period, especially in regions where the situation in the employment market, and consequently income prospects, are clearly improving, like in the USA, for example. Under these conditions gross domestic product in advanced economies should see only subdued growth. Indeed, gross domestic product looks set to increase by a mere 1.3% in 2012, while output should increase by 1.8% in 2013.

Economic activity in emerging economies will remain constrained by weak growth in advanced economies over the forecasting period. Domestic forces for growth are only expected to gather strength again gradually. Gross domestic product looks set to increase more slowly in 2012 and 2013 than in the two preceding years. The overall increase in world output is forecast to decline to 2.5% in 2012, but should return to last year’s level of 3.0% in 2013. World trade will pick up gradually over the forecasting period. It should show an average annual increase of 4.4% in 2012 and will probably increase by 6.6% in 2013.

After a lull that lasted several months, the German economy picked up again in spring 2012. Thanks to the impression of an escalating debt and confidence crisis in Europe and a cyclical downturn, overall economic output saw practically no increase last winter. Since then the world economic environment has brightened slightly and measures taken to mitigate turbulence in the Eurozone have helped to stabilize the situation in the financial markets and to reduce economic uncertainty. This is reflected in confidence indicators among other things. The business expectations of German companies have followed an upward trend since December 2011. The consumer climate has also improved again. However, the latest increases in risk premiums for Spanish and Italian government bonds show that the debt and confidence crisis continues to smoulder.

The Institutes expect the forces driving the economy to take the upper hand in Germany during the forecasting period. Although economic activity in the rest of the Eurozone remains weak, the ECB’s interest rate policy for the entire Eurozone and Germany’s attractiveness as a “safe harbour” is exerting a downward pressure on interest rate levels, which is massively boosting investment. Moreover, the price competitiveness of German companies, primarily due to the weakness of the euro in the currency markets, is higher than at any time over the past 30 years. Exports therefore continue to follow an upward trend despite the recession in German manufacturers’ key sales market, the Eurozone, and the slow pace of improvement in the global economic environment. The labour market is ultimately in very good shape, which is partly due to past labour market reforms; and the continued decline in the structural unemployment rate is stimulating earnings, earnings expectations and private consumption.

Against this background, the increase in output should clearly gain impetus as of the spring and aggregate economic capacity utilization should increase significantly over the forecasting period. As in previous years, the main impulses will come from domestic demand, and especially from investment and private consumer expenditure. In view of weak economic activity in the rest of the Eurozone exports, on the other hand, are only expected to pick up haltingly, which is one of the reasons why international trade will not make any positive contribution to growth in gross domestic product in 2012 and 2013. Overall, real gross domestic product should total 0.9% in 2012. The 68% forecast interval extends from 0.2% to 1.6 %. In 2013 gross domestic product should increase by 2.0% (forecast interval 0.5% to 3.5%).

The number of persons in employment should increase by 470,000 in 2012 and by 325,000 in 2013, but the decrease in unemployment will be disproportionately lower because the size of the workforce is expected to increase, partly due to higher worker immigration. The unemployment rate will nevertheless decrease by around half a percentage point in both years and should drop to 6.2% by the end of the forecasting period.

Against a background of rising capacity utilisation and the growing labour scarcity, the upsurge in wages and prices should increase significantly in the forecasting period. Real wages will probably increase by over 3% in both years. Consumer prices will rise above the 2% mark both during this and next year to 2.3% and 2.2% respectively.

The Federal Government’s budget deficit should drop to 0.6% in relation to gross domestic product in 2012 due to its consolidation policy. In view of the favourable economic situation, the Institutes forecast a further decrease to 0.2% in 2013. Structurally the deficit ratio should be 0.6% this year (at almost normal levels of production capacity utilisation) and looks set to drop to 0.4% next year.

The biggest downside risk to economic development in Germany remains the debt and confidence crisis in the Eurozone, which essentially remains unresolved. Although the ECB has reduced stress in the banking system thanks to extraordinary liquidity policy measures, in the end, this has only succeeded in winning time. Should the financial markets lose their confidence in the Eurozone countries once again – perhaps because the requisite financial policy reforms are not implemented - this will affect the German economy too. However, there is also potential for stronger growth than forecast here. Interest rates in many countries have fallen to historical lows. This is especially true of Germany, where monetary framework conditions are particularly favourable at the moment.

Economic policy has remained overshadowed by the euro crisis in recent months. The Institutes once again propose that an insolvency mechanism should be created for Eurozone countries. Moreover, they argue that responsibility for the regulation and supervision of the interconnected, pan-European banking and financial system should be bundled in a central institution like the European Banking Authority, which has strong enough powers and sufficient financial resources to recapitalize distressed, systemically important banks and liquidate them if necessary, while protecting the system. Countries absolutely must conform with the fiscal pact to contribute to the sustainability of public finances. There should only be recourse to the ESM in exceptional cases, namely in cases of acute liquidity problems, to limit the problem of “moral hazard”. For the moment it still remains unclear what course of actionis to be taken if the problems in the financial sector escalate.

To date all concerned have obviously relied on intervention by the ECB in an emergency. To prevent ailing financial institutions from collapsing, it provides unlimited liquidity, which is now available for a term of three years and at reduced collateral requirements. This has led to massive distortions and has therefore generated economic costs at other levels, which is clear from the Target 2 balances. Moreover, in the absence of suitable mechanisms for resolving the crisis, there are fears that the ECB will not normalize its measures until none of the Eurozone’s banking systems present a threat any longer. However, this would amount to orienting monetary policy towards the weakest member state, rather than the Eurozone as a whole. The ECB could then no longer act appropriately to fight inflation, with negative consequences for price stability.

There are different views as to how the ECB can be released from its predicament. The IWH and RWI believe a “Buyer of Last Resort” is necessary to specifically ensure that the sustainability of a country’s public finances is not lost due to a mere increase in interest rates. IfW and Ifo do not believe that this would be effective because German exposure volumes would be significantly increased, while pressure from the capital markets on crisis countries would be considerably lowered, reducing the impetus of reform.

The German Bundestag has run significant risks for Germany by approving the bailout packages. To ensure the Federal Republic’s ability to act in the future – partly in view of these risks – swift progress towards budget consolidation needs to be made in Germany. Its debt ratio of 80% of gross domestic product is still far above the agreed upper limit of 60%. Against this background, the current flagging in consolidation efforts is to be seen critically. Cyclically-induced additional revenues and reduced expenditure are no replacement for structural adjustments. The budget discharge announced by the federal government with its “future package” (Zukunftspaket) should be implemented; and in cases where targets no longer seem realistic, other measures should be passed. Shifting the load from the federal budget to the social security system – as the Federal Government plans to do – does not constitute an effective tool since it does not change the overall deficit. However, the Federal Government is not the only body with obligations as far as the debt brake is concerned. Many Länder governments will also have to make serious efforts to achieve structurally balanced budgets as of 2020.

The Institutes have analysed the debt sustainability of the crisis countries Greece, Ireland, Italy, Portugal and Spain using projections of their debt ratios. In a baseline projection, which assumes that the reform measures implemented in the crisis countries to date gradually begin to take effect and that interest rates do not return to record peaks, it should be possible to stabilise the situation in Ireland, Italy and Spain; and these countries should be able to reduce their debt ratio in the mid-term. However, any weakening of the will to reform and/or significantly higher interest rates on existing state debt would make public debt unsustainable. In Greece and Portugal the situation is more complex. The debt situation in both countries can at best be expected to stabilise at a very high level.

Long version as pdf-file (only in German)

For further information, please contact:
Prof. Dr. Roland Döhrn, Tel.: +49 201 81 49-262, email
Sabine Weiler (press office), Tel.: +49 201 81 49-213, email

Key Data of the Forecast for Germany

^a)Nationally. - ^b)Unemployed as % of civil working population (definition according to the Federal Employment Agency). - ^c)Consumer price index (2005 = 100). - ^d)National employes compensation per worker in relation to real GDP per employed person. - ^e)compiled on a national accounts basis (ESA 95). - Sources: Federal Statistical Office; Federal Employment Agency; German Bundesbank; 2012 and 2013: Institute forecast.