Kiel Institute winter forecast: Small plus and major risks for Germany’s economy

"The German economy can breathe a sigh of relief, but no one should sit back in the face of massive risks, least of all economic policymakers," comments Stefan Kooths, Vice President and Head of Economic Forecasting at the Kiel Institute, on the current forecast for Germany (German Economy Winter 2022) and the World Economy (World Economy Winter 2022).

The reason for the now slightly improved outlook is that energy prices for businesses and consumers have risen less sharply than expected, partly as a result of government interventions in the form of price brakes for gas and electricity. This in itself strengthens private purchasing power, but cannot compensate for the losses from still high upward price pressure.

Energy crisis costs 4 percent of economic output

All in all, the energy crisis is weighing heavily on the German economy. Compared to the economic outlook as of one year ago—i.e. prior to the Russian invasion of Ukraine—, economic output is reduced by180 billion euros in 2022 and 2023 alone and will be 4 percent lower at the end of this period.

High wholesale prices for gas and electricityare making Germany's energy imports significantlymore expensive. In 2022, an extra amount of 80 billion euros flows abroad, and in 2023 the energy import bill will rise by a further 45 billion euros.

Accordingly, the electricity and gas price brakes are placing a significant burden on public budgets, which will incur additional expenditure totaling more than EUR 100 billion in the next two years.

After a good 60 billion euros (1.7 percent/GDP) this year, the overall government budget deficit will rise to 160 billion euros (4 percent/GDP) in 2023. In 2024, the deficit will fall again to around 90 billion euros (2.2 percent/GDP), with gross debt then standing at just under 68 percent.

High fiscal price for lower inflation numbers

As such, the government subsidies for gas and electricity customers will push down the inflation rate by 2.4 percentage points in the coming year. The abolition of these subsidies from April 2024 on will raise the inflation rate by 1.1 percentage points in the same year. Overall, the Kiel Institute expects inflation rates of 8 percent (2022), 5.4 percent (2023) and 2.2 percent (2024).

"The lower inflation rate in the coming year comes at a high fiscal price via massive subsidies that only superficially alleviate the energy crisis. The aid is far too broadly based and thus increases inflationary pressure elsewhere in the economy. This is neither in line with a market-based approach nor with macroeconomic stability," says Kooths.

"The crisis cannot be bridged by permanent subsidies but calls for a root cause treatment. Politically, this requires a new energy strategy that fundamentally strengthens the energy supply and doesn't keep sealing the cracks with ever more debt."

Gas shortage still possible in 2023/24

With increases of around 5 percent in each of the next two years, wages and salaries per employee are likely to rise as strongly as they last did 30 years ago. Real incomes will not rise noticeably again until 2024, by 1.7 percent, after three years of decline.

Despite the economic slowdown, the labor market is robust, partly because companies are still desperately seeking skilled workers. The unemployment rate is expected to rise only slightly, from 5.3 percent (2022) to 5.5 percent (2023) and 5.4 percent (2024).

Although the industry is being hit hard by the energy crisis - order intake is falling, energy-intensive sectors are cutting back production - it is nevertheless benefiting from an unusually high order backlog, partly as a result of global supply bottlenecks, which alone secures production for almost eight months. This can now be worked off as shipping delays and material bottlenecks gradually ease in view of the weakening global economy.

Gross value added in themanufacturing sector is therefore expected to increase by around 3 percent in each of the next two years, despite the difficult economic environment at home and abroad. Exports are expected to grow by 2.8 percent this year, 1.9 percent in 2023 and 3.6 percent in 2024.

"Germany's economic prospects are on very shaky ground, as the risks in energy supply remain enormous. A gas shortage next winter is by no means off the table, and volumes and prices of LNG supplies in the coming year are still unclear. The economic picture has now brightened slightly, but it is still too early to sound the all-clear signal," says Kooths.