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Ifo Economic Forecast 2009/2010: Downturn Continues Press release Munich, 23 June 2009 2 The world economy is in the midst of the deepest recession since the Great Depression. The pace of the contraction, however, has probably slowed since this spring. Worldwide programmes to boost economic activity have been implemented, and the expansive monetary policies of the central banks are gradually having an effect. Also measures to stabilise financial markets have been taken in numerous countries. Finally, real incomes have been boosted by the strong declines in raw material prices. The world economic climate as surveyed by the Ifo Institute improved in the second quarter of 2009 for the first time since autumn 2007. However, the rise of this indicator was solely the result of more favourable expectations for the next six months, whereas the appraisals of the present economic situation continued to deteriorate, falling to a new historical low. A quick recovery of the world economy is not to be expected. A major problem is still the precarious equity capital situation of the banking sector in the United States and Europe. This is the result of the necessary write-downs and valuation adjustments of a magnitude that threatens the existence of the banks. To be sure, after the insolvency of Lehman Brothers in September 2008, massive government intervention has prevented more bankruptcies of major financial institutions. However, additional value adjustments of considerable amounts are still looming. Also the recession-induced failure of loan repayments may play an increasingly important role. In several important countries there is also a depression on the real-estate markets, which likewise will increase banks’ write-off requirements. As a result, the banks will strive to reduce their balance sheets noticeably in order to improve the extremely strained relationship of their capital to their balance-sheet totals. This will affect bank lending policies towards private households and non-financial businesses especially when the demand for credit, which has been dampened by the recession, picks up again. For this reason it can be expected that the forces of economic recovery will unfold only very hesitantly and that the current downturn will last much longer than would otherwise be expected. This economic forecast assumes that the US recession will continue in the summer halfyear of 2009. It is expected that private consumption will decline in spite of the extensive support measures from fiscal policy, also because the labour-market situation 3 will deteriorate further. The stabilisation of investments will only be gradual. In Japan economic activity will recover slowly after the collapse at the beginning of the year. Although domestic demand is expected to decline, exports should show at least hesitant growth impulses, especially since the economic situation of important trading partners should brighten somewhat. In the euro area the weakened economic situation will continue. Private consumption will decline as a result of the worsened labour market situation and investments will fall further. Exports will also provide no stimulus to economic growth. Economic expansion in the newly industrialised countries is likely to recover gradually in the forecast period. In China economic activity will benefit from the large economic stimulus package; however, expectations of a quick return to the former boom phase are dampened since exports, a major pillar of the previous upswing, will continue to suffer from the global economic weakness. In India economic activity will remain relatively strong due to the solid expansion of domestic demand. In the other eastern Asian countries, however, it will only gradually stabilise after an initial shrinking. In Latin America, the stimulating effects of monetary and fiscal policy measures, which are extensive in some countries, will support the economic recovery. Some of the important countries of the area should increasingly benefit from the recent incipient recovery of raw material prices. In total, world GDP will decline by 1.8% in 2009 before it increases by 2% in 2010. This forecast is based on the countries taken into consideration by the International Monetary Fund (IMF), whose growth rates were weighted using purchase power parities of 2008. The increase in prices will flatten out strongly worldwide. Unemployment is expected to continue to increase clearly as a result of the economic weakness. This forecast is based on the assumption that the price for Brent crude oil will fluctuate at 70 US dollars per barrel in the forecast period and that the euro/dollar exchange rate will stabilise at 1.40. Under these assumed conditions, world trade will continue to 4 decline initially before it gradually recovers. It will fall by 14% in 2009 and increase by 3% in 2010. The German economy is experiencing the worst recession in the history of the Federal Republic. According to the now available official statistics, economic output fell in the first quarter of 2009, seasonally and calendar adjusted, by 3.8%, and already in the fourth quarter of 2008 the economic output had declined by 2.2%. Germany has thus experienced the sharpest collapse in growth of all major European economies. Also in an historical perspective, this is without precedent. The main reason for this catastrophic economic development since last autumn is the simultaneous worldwide collapse in demand for capital goods and consumer durables that occurred in the wake of the international financial crisis and collapse of confidence. The German economy has been particularly hard-hit by this external demand shock due to its high dependency on foreign trade and its specialization in cyclically sensitive industrial products. After the drastic drop in the winter half year 2008/09, economic output has likely also fallen in the second quarter, albeit at a reduced pace (current rate: –0.7%). Signs of the start of a gradual stabilisation are seen in recent developments of a number of important cyclical indicators such as production and incoming orders as well as the Ifo Business Climate. The decline in economic output comes especially from manufacturing as well as the sectors of financing, leasing and business services. For the first half-year 2009 a seasonal and calendar adjusted decline in real GDP of 5.2% will occur in comparison to the second half year 2008; in a year-on-year comparison the decline amounts to 7.5%. The downturn will continue throughout the forecast period. After a temporary increase in summer primarily driven by fiscal stimulus, the basic tendency of economic output will be further contraction. Although no further dampening effects are foreseeable from net exports, the decline in equipment and construction investments will continue. The reduction in inventories has also not yet been concluded. In addition, private consumption will fall starting in the autumn months due to the decline in employment and strong increases in unemployment. Not until spring 2010 can we expect the fall in 5 production and demand to bottom out. Afterward, real economic output should increase somewhat. As the world economy gradually recovers, exports will increase somewhat; also equipment investment should recover moderately. Towards the end of 2010, anticipatory effects are likely due to the restoration of the declining balance method of depreciation. The economic stimulus packages will stimulate construction investment. On the whole, however, the economic dynamics will not be strong due to the weakness of private consumption so that the operating rate of the economy will fall. On average for 2009 total economic output will decline by 6.3%, in both unadjusted and calendaradjusted terms. In 2010, due to the low initial level, a decline of only 0.3% (calendar adjusted: 0.4%) is expected. The recession will become increasingly noticeable on the labour market as of the summer months of 2009. The build-up of reduced working hours will come to a standstill and the numbers of unemployed will increase at an accelerated rate. On average for this year, employment numbers will fall by 460,000 and next year by as much as 1.05 million. The number of unemployed will rise by 320,000, on average for 2009, and by 760,000 in 2010. At the same time, consumer prices will remain virtually stable. For this year an inflation rate of 0.2% is expected; in 2010 it will average only 0.4%. The budget deficit will grow unusually strongly in the forecast period. In 2009 the deficit will increase to 3.4% of nominal GDP but in 2010 to 6.0%. This is caused by the economic situation, which will lead to enormous revenue shortfalls and additional expenditures, but there are also strong discretionary impulses in connection with the government’s stimulus packages. Ifo Economic Forecast 23 June 2009 Federal Republic of Germany Key Forecast Figures 2007 2008 2009 2010 (1) (1) a) 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) -0,4 2,2 4,3 6,9 1,8 8,0 1,1 7,5 5,0 2,5 0,1 1,8 4,4 5,9 3,0 6,5 1,8 2,7 4,2 1,3 0,3 1,4 -10,7 -22,4 -3,3 5,5 -1,8 -17,0 -8,3 -6,3 -0,8 1,7 0,4 -0,6 1,0 0,9 -0,3 2,3 2,4 -0,3 39768 3776 40330 3268 39856 3581 38806 4337 8,7 7,5 8,3 10,1 2,3 2,6 0,2 0,4 - EUR billion -4,2 -3,1 -80,1 -141,1 - in % of GDP -0,2 -0,1 -3,4 -6,0 2,7 0,7 -4,6 -0,3 2,1 3,3 0,1 0,5 b) Employment (1.000 persons) Unemployment (1.000 persons) c) Unemployment rate (in %) d) Consumer prices (% change on the previous year) e) General government financial balance memo item: Real GDP in the EMU (% change on the previous year) f) Consumer prices in the EMU (% change on the previous year) 1) Forecast by the Ifo Institute.- a) Price adjusted.- b) Domestic employment.c) Unemployment as a % of labour force (employed and unemployed).- d) Consumer price index (2005=100).e) On national accounts definition (ESA 1995).-f) Harmonized index of consumer prices (HICP, 2005=100). Source: Eurostat, Federal Statistical Office, Federal Agency of Labour, forecast by the Ifo Institute.