The German economy is approaching boom territory. GDP growth of 1.7 percent is likely in 2017, rising to 2.0 percent in 2018. Macroeconomic capacity utilization is running at above-average levels and will continue to rise. Six years into the expansion, it will reach a peak not seen since the boom year of 2007. Public budgets continue to register record surpluses.
The German economy is in danger of overheating. In its latest economic forecast published today, the Kiel Institute for the World Economy (IfW) predicts that gross domestic product (GDP) will grow by 1.7 percent this year and 2 percent next year. As such, it is confirming its previous estimates. The lower increase in the current year is attributable to the relatively high number of holidays that fall on a business day. After adjusting for the number of business days, the forecast for 2017 is for GDP growth of 2 percent. According to the forecast, total economic production in Germany will grow through 2018 at a rate in excess of sustainable economic growth, which will increase the downside risks.
"Given that capacity utilization is already significantly above normal, Germany is on the brink of a boom. Against this backdrop, the risks to the economy are also increasing," said Stefan Kooths, Head of the Forecasting Center at the Kiel Institute, commenting on the economic forecast for the period to 2018 published today. "The German economy is approaching boom territory, albeit with cyclical swings that are less pronounced due to the extended nature of the expansion."
Corporate investment picking up significantly, exports helping to drive growth
Overall, the upswing in Germany is becoming more broadly based. Private consumption is likely to expand at a markedly slower pace, since the purchasing power of disposable incomes will be significantly eroded by the oil price-induced rise in inflation to just under 2 percent. Public consumption will likewise no longer expand quite as rapidly as before, since there is unlikely to be any additional spending in association with refugee migration. However, investment is set to gain momentum.
Capital spending on plant and equipment, for example, is likely to gradually accelerate following a softening in recent quarters caused by the uncertain international environment. Aside from weather-related fluctuations, investment in construction will continue to expand strongly throughout the forecast period, not least due to the availability of low-cost finance. With the gradual revival of the global economy, exports are likely to increasingly contribute to higher growth.
Record public budget surpluses
The overall government budget surplus will probably exceed the previous year's record level of EUR 20 billion in the current year and remain very substantial in the following year. "The large surplus is primarily due to strong economic growth and low interest rates and is therefore a temporary phenomenon. In terms of pursuing a prudent fiscal policy, the scope for sustained increases in expenditure or reductions in revenue is severely limited," said Kooths.
Downside risks on the rise
With the German economy operating beyond capacity, the cyclical downside risks are increasing. "The expansion is now in its fifth year and capacity utilization increasingly exceeds the long-run average. No significant monetary policy response to the emerging boom in Germany in the form of higher interest rates is anticipated during the period covered by the forecast. Having said that, this unusually long expansion phase will not last forever. Whenever production levels exceed potential, a correction has to happen sooner or later," said Kooths.
"Economic policy needs to curb excesses during a boom as far as possible and not add fuel to the fire by making unfunded promises in an election year. The German economy is already redlining in overdrive, so shifting up a gear isn't an option. In fact, we're going to lose a gear in the next few years due to adverse demographics. There is then a risk of increased demands on the state welfare system coinciding with a weaker economy," Kooths warned.
Global economy shrugs off uncertainty
Sentiment is good, especially in the advanced economies; the economic picture has also improved appreciably in the emerging markets. Global production is expected to rise from 3.1 percent last year to 3.6 percent and 3.7 percent in 2017 and 2018, respectively, based on purchasing power parity. This means that the economic researchers at the Kiel Institute are revising their March forecast upward slightly by 0.1 percentage points for both years. "While there is considerable uncertainty around future economic policy, it doesn’t appear to be having a significant dampening effect on economic activity at present," said Kooths.
Ongoing recovery in the US and eurozone, lower growth rates in China
In the United States, output growth is likely to accelerate to 2.2 percent this year and 2.5 percent next year, thanks in part to significant fiscal stimulus. The economic recovery in the eurozone will continue, with growth rates of around 2 percent both this year and next. While growth rates in most emerging markets are likely to continue growing, a gradual slowdown in economic expansion is to be expected in China. "Risks to this forecast stem mainly from the political uncertainty and potential problems associated with the upcoming normalization of monetary policy," said Kooths.