Economic Outlook: Broad-based Expansion in Germany

Since a relatively large number of public holidays fall on a business day in 2017, gross domestic product (GDP) growth of 1.7 percent will fall short of the previous year's figure. After adjusting for the number of business days, however, economic dynamics slightly gain momentum. In 2018, GDP is likely to grow by 2.0 percent. Those are the conclusions of the economic forecast for the period to 2018 published today by the Kiel Institute for the World Economy (IfW). "All in all, the robust upward trend of the German economy is set to continue, with expansion now being broader-based," said Stefan Kooths, Head of the Forecasting Center at the Kiel Institute.

Rise in consumer spending slowing

With 1.6 percent, consumer spending is expected to rise less sharply than previously. The reasons include higher energy prices, which hit purchasing power, and lower extra public expenditure on refugees. Following growth of 2 percent, real incomes are likely to increase by only 1.2 percent this year and by 1.4 percent next year.

Exports, meanwhile, will advance significantly and grow by 3.7 percent this year and 5 percent in the next year. The buoyant US economy, continuing recovery in the euro zone, and gradually improving outlook in the emerging markets are the dominant factors in this respect. The current account surplus is likely to fall by one percentage point relative to GDP, declining to 7.5 percent in the forecast period and exceeding the threshold for the European Macroeconomic Imbalance Procedure within the forecast horizon.

"Considerable political uncertainty remains around the world," said Kooths. The researchers regard the risk of a trade war between the EU and the USA as relatively low, though, given that US firms have very high direct investments in the European single market, where they generate sales of 2.5 trillion dollars, that are five times the value of US exports. "US firms thus have a vital interest in preventing any major disruption of transatlantic economic relations," said Kooths.

Construction investment set to rise particularly sharply

The forecast indicates that investment is now also likely to climb more significantly. This applies in particular to investment in construction, which is set to increase very strongly, gaining a projected 2.6 percent in the current year and accelerating to around 4 percent in the following year. "The low interest rate environment is continuing to act as a powerful stimulus, while public sector construction investment is supported by healthy public budgets," commented Kooths. Spending on capital equipment will also pick up, gaining speed markedly in the course of the current year. It will rise by 1.4 percent over the year, followed by 5 percent in 2018.

Inflation up to almost 2 percent this year

The researchers expect pressure on production capacity to grow as a result. The output gap is predicted to rise from 0.8 percent in the past year to 1.1 percent (2017) and 1.7 percent (2018). Inflation is likely to be much higher than previously, both in this year and next year. The recent surge to more than 2 percent in February is due to base effects and the sharp rise in the price of oil. Excluding energy prices, the inflation rate rose rather less strongly, standing at 1.5 percent in January compared to 1.2 percent for the year 2016. Since the base effect will fade out during the year, inflation should fall back again somewhat in the spring. During the period covered by the forecast, however, growing pressure on production capacity is likely to become increasingly noticeable, with inflation rising to 1.8 percent in this year and the next.

"The European Central Bank today should provide a clear signal for a soon ending of the ultra-expansionary monetary policy. There is already ample liquidity in the euro area while securities markets are drying up," said Kooths. "The longer artificially low interest rates remain in place, the more distortion they will create—in the real estate and bond markets, for example—and the more painful the subsequent correction will be."

Euro area: initial signs of greater momentum

The economic recovery in the euro area remains modest but solid overall, although there are initial signs of greater momentum, say the researchers. They expect GDP to grow by 1.8 percent in 2018 and 1.7 percent in 2018. "A number of different sentiment indicators have improved in recent months, suggesting that the underlying economic trend is accelerating. But key economic problems remain that are of a non-cyclical nature," said Kooths.

Following the recent surge in consumer price inflation to 2 percent, the researchers expect the current price effects of energy prices to fade out and the inflation rate to rise by almost 1.5 percent to 2018.

World Economy: expansion continues

The world economy has gained traction in the course of 2016 despite elevated policy uncertainty and seems to have picked up further in the beginning of 2017. The change in the US government apparently has led to expectations of substantial policy stimulus, while a competitive valuation of currencies supports growth in Europe and Japan. In the emerging countries, the trend towards weakening economies has been arrested in the course of last year and the outlook is for a gradual acceleration of growth. Growth in global output – at PPP – should increase to 3.5 percent and 3.6 percent in 2017 and 2018, respectively, up from 3.1 percent last year. Risks to the forecast are, however, prominent, partly related to the fact that the new US government has heralded sweeping policy changes but so far not been sufficiently concrete with its plans.

Comments by Stefan Kooths on the latest forecast:

"This isn’t the time to turn on the spending taps"

"The strong economy shouldn’t tempt politicians to turn on the spending taps and abandon key reforms that have been instrumental in securing prosperity and low unemployment. In Germany, for example, the debate about further amendments to the Hartz labor market reforms has been re-ignited. The arguments and proposals put forward to date are hardly likely to boost performance of the German economy. Incentives for rapid re-integration offer the best protection against long-term unemployment. The one-year period should also provide enough time to find a job that is a good fit with the job seeker's qualifications.

As in any insurance system, the fairness principle behind unemployment insurance is based on the idea that the community of policy holders should cover the cost of an individual claim by paying benefits to the affected person. Longer membership in the insurance system does not establish a claim to higher benefits, in the same way that a long-time holder of health insurance cannot claim enhanced medical services.

Demographic ageing of the population will reduce the domestic pool of workers significantly within the next few years. This will not only cause a scarcity of labor on the employment market, leading to a stronger market position for available workers, but also necessitate longer working lives. This is another reason why all proposals that involve pensioning off older workers through explicit or implicit early retirement are counter-productive. Future growth potential is set to fall for demographic reasons. It is therefore foreseeable that distributional conflict will increase in the medium term."