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IfW winter forecast: recovery in Germany set to continue

14.12.2015

Predictions for GDP growth in Germany: +1.8 percent in 2015, +2.2 percent in 2016, +2.3 percent in – Employment, wages, and consumer spending will continue to rise sharply – Refugee-related spending will have positive near-term impact on GDP – Almost half a million refugees expected to join labor market in 2017 – Budget surplus shrinks – No rapid recovery in emerging markets, likely long-term reduction in Chinese growth rates

Economic researchers at the Kiel Institute for the World Economy (IfW) believe that refugee-related spending will have only a moderately positive effect on GDP over the near term. They are raising their forecast for 2016 accordingly, from +2.1 percent to +2.2 percent. The researchers continue to expect growth of +1.8 and +2.3 percent, respectively, for 2015 and 2017. "Strong consumer spending remains the driving force behind the recovery and investment spending is also expected to rise faster," says Stefan Kooths, head of the IfW Forecasting Center. "Robust growth in incomes due to favorable labor market trends has delivered the biggest spending increase in 15 years. A number of temporary factors are also boosting purchasing power, such as low oil prices, pension increases, and tax cuts."

The encouraging economic outlook for Germany is at odds with the current weakness in industrial production. One reason is that domestic drivers are playing a significantly greater role in today's recovery than in the past, which favors the service sector. German foreign trade remains set for expansion, despite a disappointing third quarter. "The third-quarter weakness looks like a temporary phenomenon. We expect exports to rise again by the end of the year, not least due to the recent depreciation of the euro," says Kooths. The same applies to investment. Following a lull during the summer months, a rebound is predicted, supported by a favorable environment (low interest rates, strong income growth, healthy government finances, an improving outlook for sales and earnings both within Germany and internationally). Private housing construction will continue to rise strongly, driven by demand and good availability of finance.

Inflation going up, unemployment decreases no longer, refugees gradually entering the labor market

The IfW researchers expect consumer prices to remain largely flat this year due to falling oil prices. As price dampening effects of the low oil price expires, a distinct inflation is expected to accelerate to 1.2 percent in 2016 and to 1.8 percent in 2017. While employment continues to rise in the next two years, potential labor force also is expected to rise gradually, due to immigration from the EU and the high refugee migration. Therefore the decline in unemployment comes to a standstill over the forecasting horizon. Refugees are expected to enter the labor market only slowly due to the large number of pending asylum cases; in addition, refugees are not included in unemployment statistics while attending integration courses and taking part in other programs to prepare them for work. IfW calculations suggest that the potential labor force will then rise appreciably over time due to the influx of refugees, increasing by a total of 470,000 by 2017.

Balanced budget in jeopardy

Following the record surplus of more than EUR 28 billion in 2015, Germany will just about manage to balance its general public budget in 2016 (based on national accounts), say the researchers. The main reasons cited are pension increases, tax cuts, additional expenditure resulting from the mass influx of refugees, and public-sector efforts to boost investment. “The federal budget is created according to other accounting principles and is not explicitly covered by our forecast, but it is assumed that a balanced budget in 2016 can only be achieved due to high provisions in the current financial year," says Kooths.

No surprises in Europe and the rest of world, challenges ahead for emerging markets and China

According to the IfW forecast, the euro zone economy will gradually gain momentum and grow by 1.7 and 2.0 percent over the coming two years. The recent terror attacks are not expected to have any significant effect on production or demand. "Past experience suggests that the economic impact of this type of incident is low in advanced economies," comments Kooths. The IfW forecast predicts that global production calculated on the basis of purchasing power parity will improve slightly from a very modest 3.1 percent this year to 3.4 percent and 3.8 percent in 2016 and 2017, respectively. In the U.S., the researchers expect production to rise by 2.8 percent next year and 3.0 percent in 2017, following an increase of 2.5 percent in 2015.

Emerging markets will struggle to make progress, with the slump in commodity prices and deep-seated structural problems preventing a rapid recovery. Although the Chinese economy is likely to pick up speed initially, partly due to economic policy measures, the long-term trend toward lower growth rates looks set to continue. The IfW experts believe that the global economy remains fragile. Financial markets in particular are a source of risks, with increasing monetary policy divergence between the major currency areas potentially sparking turbulence. "The Chinese economy also continues to look shaky," says Kooths.

Comments by Stefan Kooths on the current forecast: "No economic stimulus program under the guise of aid for refugees"

“Given a monetary environment that remains too loose for Germany, it is vital for the country to stay focused on stabilization at home. The recent expansion of the ECB's quantitative easing program underlines the bank's determination to keep interest rates in the euro zone at record low levels for the foreseeable future. As such, Germany will continue to face a monetary environment that is far too accommodative for the country's economic situation during the forecast period. The resulting expansionary impact on the domestic economy and on foreign trade threatens to push capacity utilization in Germany above the current approximately normal level. This could lead to painful adjustments at a later stage. German economic policy is powerless to influence the monetary policy environment. This makes it all the more imperative for Germany to ensure that overall financial policy does not provide additional stimulus. This includes public expenditure resulting from the arrival and integration of an unusually large number of refugees. In the period covered by the forecast, this spending is equivalent to a stimulus package. While the decision to admit refugees was taken for humanitarian reasons, it should now be followed by a serious discussion of the consequences for financial policy. These could involve the reallocation of resources within the federal budget or tax increases. Since dealing with the influx of refugees obviously has a high priority, other public projects must have become relatively less important in terms of the political agenda. As such, this is not about choosing between balancing the budget and helping refugees. Rather, the issue is whether projects that now appear to have a lower priority justify deviating from the pursuit of a balanced budget in a normal economic environment.”

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