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Autumn 2011 Joint Economic Forecast:
Adverse Effects
on the German Economy
from the European Debt Crisis
Press Summary
Project Group Joint Economic Forecast
Completed in Essen on 11 October 2011
Adverse Effects on the German Economy from the European
Debt Crisis
In summer 2011, the outlook for the global economy deteriorated markedly. In Europe
in particular, the sovereign debt crisis threatens to escalate into a banking crisis. This is
having increasingly adverse effects on the German economy. The greatly heightened
uncertainty will dampen domestic demand, and foreign trade will no longer contribute
to expansion because of the difficult situation of major trading partners. The Institutes
expect the gross domestic product to increase by 2.9% this year and by only 0.8% next
year. The unemployment rate will decline only slightly from 7.0% to 6.7% in 2012. The
expected inflation rate of 2.3% in 2011 and 1.8% in 2012 will be determined more and
more by domestic price increases. The government’s budget deficit will decline to 0.9%
of GDP this year and 0.6% next year. The greatest risk is an escalation of the European
debt and confidence crisis, because of which the financing conditions for businesses
could deteriorate noticeably. Economic policy in the EU has been heavily focused on
using all possible means to prevent the insolvency of a euro country. Instead of this
course, it should create a workable insolvency mechanism for states and a European
procedure for the recapitalization and, where necessary, an ordered insolvency of banks.
The outlook for the global economy deteriorated markedly in summer 2011. Businesses and
households in the US and Europe regard the future with increased pessimism, and in financial
markets, indicators such as a slump in share prices point to a downturn. In Europe, the sovereign debt crisis threatens to escalate into a banking crisis, since many banks hold a large
amount of debt of the countries affected by the crisis.
The worldwide collapse in confidence began in July, when simultaneously the US was struggling to expand the public-debt ceiling and a new aid package for Greece and a reform of the
rescue fund were being negotiated in the European Union. The results that were reached on
both sides of the Atlantic were not perceived by the markets as a solution to debt problems
and they were not able to stop the loss of confidence. However, economic concerns were not
limited to the worsening debt crisis. Already in the months before, the worldwide confidence
indicators weakened slightly when supply chains were interrupted as a result of the natural
and nuclear catastrophes in Japan. Another stress factor was the very sharp rise in energy and
commodity prices.
Compared to the more advanced economies, demand in most emerging countries remained
buoyant. Although there was also an economic slowdown in these countries, it has been moderate so far. In addition, this was often the intention of economic policy-makers: in many
countries, including China, India and Brazil, the reins of monetary and fiscal policy have been
tightened because of high inflation, and aggregate demand has been dampened.
The growing insecurity in the European Union and in the United States will not only have a
dampening effect on the demand for goods because of deteriorating financing conditions.
Many investors and consumers will initially postpone spending decisions in the second half of
2011. Also for this reason, aggregate output will do little more than stagnate in the winter half
year in the US and will even decline temporarily in the euro area. Even if the debt and confidence crisis remains manageable, as assumed by this forecast, it will prevent a strong recov-
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ery in the euro area next year. The factor that will support business activity in the advanced
economies in the second half of 2011 and next year is the continued expansionary monetary
policy as well as the high, although weaker growth momentum in the emerging countries of
Asia, but also in Latin America and Central and Eastern Europe. All in all, total economic
output in the advanced economies is likely to expand slightly this year and next year by 1.4%
and 1.3%. Total world output is expected to grow by 2.6% in 2011 and by 2.5% in 2012.
The debt and confidence crisis in the euro area is having increasingly adverse effects on the
German economy. The greatly increased uncertainty will dampen domestic demand, and foreign trade will no longer contribute to expansion because of the difficult situation of some
major trading partners. If in this situation to a further escalation of the debt crisis in Europe
were to occur, this would have considerably negative effects on economic activity in the euro
area and in Germany. The Institutes do not expect this to happen. Although they assume that
the restructuring of the Greek government debt will continue, leading to losses among creditors, they do not regard a contagion of the same extent as after the Lehman Brothers bankruptcy as very likely. The losses would neither be unexpected nor would doubts arise as to the
liquidity of the banking system, since the ECB, with its newly created instruments, can ensure
liquidity. Under these assumptions, unlike 2008–09, a severe recession is not likely.
In the third quarter of 2011, GDP will expand by 0.6%. This is indicated by the favourable
development of output and turnover and by the further increase in employment. For the winter
half year 2011/12, the Institutes expect that the increased uncertainty and the deteriorating
global conditions will lead to a stagnation in output. Unlike the rest of the euro area, Germany
will probably not experience a recession. This is not least because German fiscal policy is
significantly less restrictive than elsewhere in the euro area, and the financing conditions in
Germany are considerably more favourable than in countries with high debt.
Assuming that the uncertainty in the euro area will slowly subside as the debt and confidence
crisis gradually loses its sharpness and as the world economy overcomes its weakness, economic activity in Germany should pick up as of the second quarter of 2012. In addition, the
monetary policy of the ECB will continue to have a relatively expansionary effect in Germany. For 2012, the Institutes expect an increase in GDP of 0.8% after 2.9% in 2011.
Because of the greater economic dynamism, the core inflation rate will probably be higher in
Germany than in many other countries in the euro area. This will be boosted by a strong increase in wages. Currently, however, inflation is marked by price increases for raw materials,
energy and food, which is not expected to continue on the same scale. In contrast, domestic
price pressure will increase. On balance, consumer prices in Germany will rise by 2.3% in
2011 and by 1.8% in 2012.
Set-backs are not expected for the labour market as a result of the brief stagnation. To bridge
the economic slowdown, the companies will initially resort to flexible working time arrangements. The expected decrease in the labour force will also be a contributing factor. The unemployment rate is therefore likely to fall slightly to 7.0% in 2011 and to 6.7% in 2012. The
fiscal position of the government will improve further. The budget deficit will decline to 0.9%
of GDP this year and to 0.6% next year. The decline in 2011 is largely due to greater cyclically induced decreases in expenditures and increases in revenue.
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The biggest risk to the forecast is a further escalation of the debt and confidence crisis that
could again shake the European financial system. The Institutes expect a further restructuring
of the Greek public debt during the forecast period. Even if this does not lead to a collapse of
the banking system, there is still the danger of contagion effects in portions of the financial
system, especially in the less transparent derivatives markets. This could increase the stress in
the financial sector and lead to less favourable financing conditions for non-financial companies. The German economy would then be dampened to a greater extent that assumed in this
forecast, and a recession would result.
However, there is also a chance for more positive economic developments in the coming
months. So far it is primarily the sentiment indicators and financial market data that point to a
significant slowdown in the economy. The data for the real economy, however, have been
largely positive. If policy-makers were able to find a way out of the debt crisis in the near
future, the mood could quickly improve and the economic outlook would brighten.
In the current difficult situation, economic policy needs to prevent a further aggravation of the
crisis. For the debt crisis in the euro area, a solution is not yet in sight despite the numerous
measures by European governments and the ECB. The rescue attempts undertaken in the past
two years have been able to contribute at most to short-term relief, because the basic problem
of unsustainable debt, particularly that of Greece, has been denied by governments for too
long.
In particular, two key European reform elements have not been addressed. Firstly, no insolvency mechanism for the member countries of the euro area has been created that would be
both effective and would provide the proper incentives. However, a default of states could
lead to major disruptions in financial markets, especially since commercial banks could lose
equity and their existence could be threatened. Therefore, secondly, a reorganisation of financial market regulation and a European procedure for recapitalisation and, if necessary, orderly
insolvency procedure for banks is desperately needed. It is positive in principle that the new
regulation for the EFSF includes this possibility.
An economic policy that seeks to prevent government default by any means contains risks.
An implicit bailout guarantee leads to the financial markets not adequately assessing the macroeconomic risks and therefore building up too high exposures. Moreover, the events since
spring 2010 have shown that the liability sums may continue to increase. There is thus the
danger that the guarantor states will overextend themselves and that their debt will increase to
more and more critical levels. If this happens, the rescue efforts would yield no benefit in the
short term – quite the contrary: the guarantor states would no longer be able to help the problem countries, and in the euro area as a whole the debt problem would be even greater.
Governments are now trying to limit the debt problems in the medium term by making the
Stability and Growth Pact stricter and by having the countries adopt national debt rules, which
some have already done or intend to do. Such steps are to be welcomed. However, they cannot be expected to lead to a rapid easing of the situation. Since in the past many countries
have not kept to the agreed rules like the Stability and Growth Pact or to their own stability
programmes, the real test of how seriously the rules are taken is still pending.
Since the measures taken by European governments have not yet led to a solution of the debt
crisis, the ECB has come under pressure to act. As early as May of last year, it purchased
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government bonds; in August this year it surprisingly took up this action again and bought
bonds, mainly of Spain and Italy. The Institutes have given varying assessments of the actions
of the ECB during the debt crisis. The majority of Institutes believe that the ECB overextended its mandate and thus put its independence at risk. In addition, the purchase of government
bonds has had adverse incentive effects. It reduced the pressure on member countries and the
European Commission to quickly implement procedures for solving the debt crisis and reduced the pressure on the countries concerned to consolidate their budgets. The consortium of
IWH and Kiel Economics does not share this view but feels that the government bond purchases by the ECB are justified because of the acute threat to the stability of the banking and
financial system and since the ordo-policy solutions recommended by all the consortia cannot
be realised in the short term. In the view of all the Institutes, however, it is not a sustainable
situation when the responsibility for economic-policy goals is blurred. The key goal is that the
ECB return to acting independently of fiscal policy and to ensuring price stability.
Against this background, German fiscal policy should maintain its consolidation course. On
the one hand, the state budget remains structurally under-funded: in the current year, with a
positive output gap of around 1%, the structural deficit in relation to nominal GDP will be
nearly 1.5%. On the other hand, the debt ratio surged from 74.2% to 84.0% in the past year,
and even in the best case – if the European sovereign debt crisis can be solved without cost to
the German budget – the debt ratio will lie above the Maastricht Treaty limit of 60%.
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Joint Economic Forecast Autumn 2011 (13 October 2011)
Federal Republic of Germany
Key Forecast Figures
2009
Percentage change over previous year
2010
2011
2012
(1)
(1)
a)
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)
-0,1
3,3
-11,4
-22,8
-3,0
0,6
-2,6
-13,6
-9,2
-5,1
0,6
1,7
5,5
10,5
2,2
4,7
2,4
13,7
11,7
3,7
1,2
1,1
7,2
9,6
5,8
4,3
2,6
7,8
7,7
2,9
0,9
1,1
2,3
3,3
1,3
4,9
1,2
2,9
4,1
0,8
Employmentb) (1.000 persons)
Unemployment (1.000 persons)
40362
3415
40553
3238
41082
2968
41274
2815
8,1
7,7
7,0
6,7
0,4
1,1
2,3
1,8
-76,1
-106,0
-23,0
-15,4
-3,2
-4,3
-0,9
-0,6
-4,2
1,8
1,5
0,4
0,3
1,6
2,5
1,5
Unemployment ratec) (in %)
Consumer prices
d)
(% change on the previous year)
General government financial balance
- EUR billion
- in % of GDP
e)
memo item:
Real GDP in the EMU
(% change on the previous year)
Consumer prices in the EMU
(% change on the previous year)
f)
1) Forecast of the Institutes.- a) Price adjusted.- b) Domestic Employment.c) Federal Employment Agency concept.- 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 Employment Agency, forecast of the Institutes.
Members of the Joint Economic Forecast Project Group:
Halle Institute for Economic Research (IWH)
www.iwh-halle.de
Press contact Tel.: (0345) 77 53 720
E-Mail:
[email protected]
E-Mail:
[email protected]
in co-operation with:
Kiel Economics
www.kieleconomics.de
Ifo Institute
www.ifo.de
Press contact Tel.: (089) 9224 1218
in co-operation with:
Swiss Institute of Business Cycle Research (KOF), ETH Zurich
www.kof.ethz.ch
Kiel Institute for the World Economy
www.ifw-kiel.de
Press contact Tel.: (0431) 88 14-331
E-Mail:
[email protected]
for the medium-term forecast in co-operation with:
Zentrum für Europäische Wirtschaftsforschung (ZEW) Mannheim
www.zew.de
RWI Essen
www.rwi-essen.de
Press contact Tel.: (0201) 81 49 292
in co-operation with:
Institute for Advanced Studies, Vienna
www.ihs.ac.at
E-Mail:
[email protected]