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Members of the Joint Economic Forecast Group
Economic Activity Hampered by the Repercussions Impact of the US Real-estate Crisis
Summary of the Joint Economic Analysis in Spring 2008
17 April 2008
In spring 2008 the world economic is overshadowed by the crisis in the real-estate and
financial sector in the United States and the worldwide financial market turbulence caused
by it. The US is on the brink of recession, in Western Europe economic activity has slowed
somewhat and in Japan aggregate demand is only increasing weakly. Nevertheless, the
expansion pace of the world economy is still considerable, especially because output in the
newly industrialised countries has been increasing strongly.
For the forecast period a further slowing of the world economic expansion is expected. The
crisis on the US financial markets and the worldwide financial market turbulence are a
burden on economic activity. They have led, especially in the United States, to asset losses
of private households which is dampening consumption. In particular, however, the
financing conditions for enterprises and households have deteriorated. The world economy
is also currently being affected by price increases, which have accelerated considerably in
recent months. In addition to the continuous rise in crude oil prices, especially food has
become considerably more expensive. This is reducing the purchasing power of private
households worldwide and benefiting producers of raw materials and foodstuffs.
In this situation monetary policy in particular faces great challenges. It must seek to find a
balance amidst liquidity problems, economic slowdown and the dangers of inflation. A top
priority at the moment is to ensure sufficient liquidity. To achieve this central banks have
adjusted their instruments in recent months. They have also reacted in different ways:
Confronted with the danger of recession, the Federal Reserve lowered its key lending rates
drastically last winter while central banks in Europe, in line with the less dire economic
outlook, have assigned greater importance to the risk of inflation and have lowered interest
rates, if at all, by small amounts.
In the forecast period, world economic activity will lose momentum in light of the
considerable burdens. The weakening of the economic dynamics will be limited, however, in
the judgement of the Institutes. This is supported by the very favourable condition of
enterprises in the non-financial sector, the strong impulses from American economic policy,
where an expansive monetary policy is accompanied by a stimulating fiscal policy, and the
high growth dynamics in the newly industrialised countries. However, the problems in the
United States are dampening activity in the other areas of the world: Via the international
financial markets, asset losses and a worsening of financing conditions are spreading. Also
the more weakly expanding imports of the United States will slow production particularly in
the countries closely linked with the US. In Western Europe the real-estate boom is coming
to an end in several countries. In the euro area the revaluation of the community currency is
an additional burden. Signs of a recession are not yet evident, but the economy in the euro
area in 2008 and 2009 will expand at a rate that is below the longer-term trend.
The newly industrialised countries will be particularly affected by the weaker economic
activity in the industrialised countries in terms of foreign trade. Their financial markets,
however, have proved to be quite robust even though share prices have fallen in some
countries in recent months. The financial market stability in the newly industrialised
countries has benefited from the fact that they are, in total, net exporters of capital and in the
meantime have high currency reserves. All in all, increases in output will be dampened in
the newly industrialised countries in 2008 and 2009, but growth will remain considerable,
however.
At 2.7 percent, world GDP will expand noticeably more slowly this year than in past years.
In 2009 the expansive forces should gradually gain the upper hand; on average for the year,
however, world output will not yet grow considerably faster. World trade is likely to expand
both this year and next year only at a moderate pace. The forecast is based on an oil price of
98 dollars per barrel (Brent) for this year and 100 dollars for next year, as well as on the
expectation that the rise in food prices will weaken. Given these assumptions, the inflation
rate will decline during the forecast period.
The biggest downside risk for world economic activity comes from the crisis in the US realestate and financial sectors. It hardly possible to foresee how far real-estate and share prices
will still fall and when they will reach bottom. Further liquidity crises of major financial
institutes are conceivable, with considerable negative consequences for financing conditions
for firms and households. American economic policy has taken decisive steps to provide
considerable sums to help contain the crisis, but the danger exists that these measures will
not be as effective as in past downturns. In this case, the US economy could be expected to
fall into a significant recession and the rest of the world would experience far weaker
growth.
In Germany the economic situation up to spring 2008 remained favourable despite a number
of adverse influences, and the economy started the year with much momentum. Unlike many
other industrialised countries, confidence indicators remain at high levels; demand and
output figures are still trending upwards. This is remarkable in light of the numerous
negative shocks that have occurred recently: In addition to the restrictive fiscal policy of last
year, these were was particularly the strong revaluation of the euro, the massive rise in oil
and food prices as well as the impact of the US real-estate crisis.
Apparently the German economy has become more robust in recent years. The danger of a
recession is thus smaller today. The growth in production potential accelerated in past years.
In addition, Germany’s international competitiveness has improved. The real-estate market
in Germany is also not marked by excessive prices so that a correction here, which may
dampen economic activity in other countries, is not likely. And finally the German banking
system has proven to be relatively robust vis-à-vis the international financial crisis. All in all
a perceptible slowdown of economic expansion is to be expected as a result of the strong
shocks but the Institutes consider a fall into recession to be less likely.
In the course of 2007 the economic dynamics weakened in comparison to the swift
preceding pace, but aggregate capacity utilisation remained high. The upswing has been
borne by business investments, stimulated by favourable profit and sales prospects at home
and abroad. The worsening of monetary conditions due to financial market turbulence has
apparently hardly affected investment activity. Exports are the second pillar of economic
activity. Private consumption, which also last year did not revive, remains the weak element
of the upswing.
The positive situation on the labour market confirms the still positive basic tendency of
economic activity. Up to March this year, the number of unemployed persons fell
perceptibly, the unemployment rate amounting to 7.8 percent, which is 1.5 percentage points
lower than a year ago. The number of wage and salary earners rose strongly, and jobs
subject to social insurance contributions grew particularly clearly. The positive picture of the
economic situation is marred, however, by the high rate of inflation. The increase in
consumer prices stood at approximately 3 percent for the first months of the year.
While German economic activity started the year 2008 with much momentum, the negative
external economic influences will become increasingly noticeable in the further course of
the year. Export dynamics in particular will clearly weaken. On the other hand, domestic
demand will expand a little more rapidly than last year. Private consumer spending will
increase perceptibly after a very long lull. Enterprise investments, however, are not likely to
grow as rapidly as in the two previous years, especially since the sales outlook abroad has
clouded over and since the cost burden has increased somewhat.
Aggregate output in 2008 will increase by 1.8 percent. The situation on the labour market
should remain favourable, although the decline in unemployment will slow perceptibly in
the course of the year. In 2008 unemployment will decrease by ca. 560,000 to ca. 3.2
million. The inflation rate will gradually fall since the increase in food prices will abate.
Consumer prices in 2008 will be about 2.6 percent above the previous-year level.
In the coming year, the economic expansion should be stronger. This assumes that the
nervousness on the financial markets will gradually disappear and that money-market
interest rates will fall. In addition, the world economy will expand a little more rapidly so
that German exports will receive more stimulus. The growth rate of real GDP in 2009 will
be 1.4 percent. In the course of the recovery, the situation on the labour market will improve
only marginally, but for the first time since 1991 average unemployment for the year will
fall below the 3 million mark.
This economic forecast carries considerable risks. The repercussions from the financial
sector crisis are very difficult to foresee since the amount of necessary write-offs is still not
known and because the extent to which real-estate prices in the United States will continue
to fall is still unsure. Simulations with models that the Institutes employ show that a
recession in Germany would be probable if capital user costs in the US and also in Germany
increase markedly.
For the first time, the Institutes have submitted a medium-term projection as a part of their
economic analysis. The outlook is patchy: In the period 2007 to 2012, real GDP should
increase by 1½ percent per annum, on average.
Economic policy-makers are currently discussing whether an economic stimulus package
similar to that in the US should be introduced in order to counter the economic weakening. It
is indeed conceivable that a counter-cyclical fiscal policy could be successful, but the
conditions for such a policy in reality are hardly fulfilled. There are considerable problems,
for example, in the timing of the implementation of such measures so that they take effect in
the weakening phase and not once the recovery phase has started. For this reason the
German government is advised against implementing such a stimulus package.
In the interest of more growth and employment, fiscal policy should pursue a strategy of
“qualitative consolidation”. In recent months, there are increasing signs, however, that the
course of only gradually expanding government expenditures will not be continued. This
would forfeit the chance to promote economic growth, for example by increasing investment
spending. If policy-makers see no scope for general tax reductions, they should at least
refrain from “hidden” tax increases, in the opinion of the Institutes.
The introduction of comprehensive minimum wages or the extension of industry-specific
minimum wages to other sectors is currently under discussion. A wide consensus exists
among economists that the employment effects would be negative in Germany. Proponents
of a minimum wage argue that no-one can live on a low hourly rate. This argument falls
short, however, because it does not take the social safety net into consideration, especially
the second phase of unemployment benefits (Arbeitslosengeld II), which prevents income
from falling below the poverty line. Even a general statutory minimum wage that is so low
that it has “no harmful effect” can ultimately damage employment considerably. True, a
hourly rate of “only” 4.50 euros is currently being discussed but such an instrument would
increasingly become the focus of election promises. For this reason it is to be feared that the
minimum wage would not remain low.
A turning away from labour-market reforms and the introduction of a minimum wage would
counteract the wage restraint practiced in recent years. Indeed, the rise in collectively
bargained wages will be greater this year and probably also next year. True, the increase still
does not exceed the present leeway for distribution, but in the coming year wages will hardly
be a stimulating factor in employment. Also because of this risk the federal government
should continue its labour market reforms and not interfere in the process of free collective
bargaining. This would be the best contribution for more employment and more growth.
The European Central Bank has been confronted with particularly great challenges in recent
months. In its measures it has differentiated clearly between providing liquidity, on the one
hand, in order to guarantee the stability of the financial market, and, on the other hand, the
requirements that result for monetary policy from a stability-policy standpoint. In recent
months, inflation has grown surprisingly strongly in the euro area. The risk is still great that
inflation expectations could solidify, finding expression in higher wage demands, for
example. Against the background of this forecast of economic activity and inflation, the
Institutes consider it appropriate that the ECB leave its key lending rate at 4 percent.
Joint Economic Forecast Spring 2008 (17.04.2008)
Federal Republic of Germany
Key Forecast Figures
2005
Percentage change over previous year
Private consumption
Government consumption
Gross fixed capital formation
Machinery and equipment
Buildings
Other investment
Domestic demand
Exports of goods and services
Imports of goods and services
Gross domestic product (GDP)
West Germany and Berlin
East Germany
Employment (1.000 persons)
West Germany and Berlin
East Germany
Unemployment (1.000 persons)
West Germany and Berlin
East Germany
c)
Unemployment rate (in %)
West Germany and Berlin
East Germany
2006
2007
2008
(a)
(a)
b)
1,0
0,9
6,1
8,3
4,3
6,7
1,9
12,5
11,2
2,9
3,0
2,2
-0,4
2,1
5,0
8,2
2,3
6,6
0,9
7,8
4,8
2,5
2,5
2,2
0,8
2,2
2,6
4,0
1,1
6,5
1,3
5,4
4,9
1,8
1,8
1,5
1,2
2,2
2,1
2,8
1,4
3,5
1,6
4,6
5,8
1,4
1,4
1,2
39006
32971
6035
4487
3300
1187
39659
33534
6125
3776
2746
1030
40130
33925
6205
3212
2292
920
40262
34042
6220
2975
2080
895
10,3
9,1
16,4
8,7
7,6
14,4
7,4
6,3
12,9
6,9
5,8
12,6
1,6
2,3
2,6
1,8
-1,1
0,2
1,4
1,7
-37,3
0,2
-6,8
1,8
-1,6
0,0
-0,3
0,1
2,9
2,2
1,5
2,2
2,4
2,1
1,4
1,7
2,8
2,6
1,7
1,6
2,2
2,1
3,0
2,3
Consumer pricesd)
(% change on the previous year)
e)
Unit wage costs)
(% change on the previous year)
f)
General government financial balance
- EUR billion
- in % of GDP
memo item:
USA: Real GDP
(% change on the previous year)
Japan: Real GDP
(% change on the previous year)
Real GDP in the EMU
(% change on the previous year)
g)
Consumer prices in the EMU
(% change on the previous year)
a) Forecast by the Institutes.- a) Price-adjusted.c) Unemployment as a % of labour force (employed and unemployed).d) Consumer price index.- e) Gross wages and salary income
created in the domestic economy per employee as a % of GDP (price-adjusted) per employed
person.- f) On national accounts definition (ESA 1995).- g) Harmonized index of consumer prices (HICP-EMU).
Quelle: BEA, ESRI, Eurostat, Federal Statistical Office, AK VGR der Länder, Federal Agency of Labor,
Forecast by the Institutes.