Trade Resources Market View The German Economy Is on The Verge of an Upturn Driven by Domestic Demand

The German Economy Is on The Verge of an Upturn Driven by Domestic Demand

The German economy is on the verge of an upturn driven by domestic demand. The improving global economic climate and decreasing uncertainty are fuelling investment. Private consumption is benefitting from favourable employment and income prospects. Real gross domestic product looks set to grow by 1.8 percent in 2014, after an increase of just 0.4 percent this year. Consumer prices are expected to rise by a moderate 1.6 percent this year and by 1.9 percent next year. The German public budget will continue to show a surplus.

The world economy picked up in the first half year of 2013. Production primarily expanded more rapidly in the advanced economies, while the pace of growth in emerging economies, in contrast, barely picked up. Growing confidence on the part of companies in most countries suggests that the economic uptick will continue in the second half of the year.

Although economic activity in the advanced economies remains constrained by structural problems, there have been signs of a recovery since the beginning of the year. The US economy has coped very well with cuts to the public budget. Japan’s new government has succeeded in clearly stimulating the country’s economy with its highly expansive economic policy, while the British economy has managed to put stagnation behind it. Finally, production in the euro area recently increased for the first time in 18 months. In emerging economies the growth dynamic remains strong overall, but has slowed down considerably in recent years. The lack of good institutions is proving a growing constraint. This is particularly true of the large emerging economies Brazil, Russia, India and China. Weaker growth in China, an economy that has heavily influenced the pace of world economic growth over the last decade, is of the greatest important in this respect.

The central banks in all of the advanced economies have announced their intention to remain on an expansive course this year and next. This announcement was credible since price dynamic and inflation expectations are already low or, in the case of Japan, a higher price dynamic would even be welcome. It is more difficult to predict when central banks will deem that the time has come to cautiously downscale the expansiveness of monetary policy. In the forecasting period, however, this problem only applies to monetary policy in the USA. The situation in the US labour market, however, will continue to improve in the winter half-year and the US Federal Reserve Bank is then expected to begin to scale back monetary expansion.

In the US the stalemate in Congress is currently blocking all financial policy decisions once again. Should no agreement on the debt ceiling for the federal budget be reached, then the USA’s ability to pay its capital market creditors is even at stake. It is assumed, however, that an agreement will ultimately be reached on raising the debt ceiling. However, this will probably not offer a stable solution to the financial policy blockade. In the euro area, the measures and timeframe for reaching overall consolidation goals remain unclear. This forecast assumes that financial policy will become less constrictive.

The slightly faster pace of world economic growth in the first half of 2013 will be sustained in the second half of the year, as well as in 2014. The improvement seen in sentiment also has fundamental roots: some of the factors constraining economic activity since the financial crisis are slowly becoming less significant. World production will expand by 2.1% in 2013, and thus at around the same pace as in 2012. In 2014 growth is expected to amount to 2.8%. The economic environment does pose significant risks to this forecast. Should the federal debt ceiling in the USA not be raised by mid-October, spending would have to be cut by the size of the current government deficit which is around 4% of gross domestic product. This would trigger a severe recession in the USA with serious implications for the world economy. The forecast of a gradual recovery of the euro area from the crisis is also by no means guaranteed.

The German economy is on the verge of an upturn in autumn 2013. Livelier growth in the world economy and decreasing uncertainty about the crisis in the euro area are creating an environment in which favourable domestic economic conditions have a greater bearing. The sharp increase in output in the second quarter of this year could not be sustained since it was due to catch-up effects after the long, hard winter. Current indicators, however, point to an underlying upward tendency in the economy.

Rising employment and considerable increases in wages have been responsible for a robust development in private consumption for some time. This development looks set to continue over the remainder of the forecasting period, since employment will increase considerably. Exports will be stimulated by a further upturn in the world economy. Exports in non-European countries have been rising rather dynamically for some time, and deliveries to the euro area will gain impetus as its economy stabilises. Overall, however, the increase in German exports will be moderate. Imports, on the other hand, will be stimulated by strong domestic demand. The contribution of international trade to growth is expected to remain negative on balance.

Against a background of decreasing uncertainty over a renewed intensification of the crisis in the euro area and a brighter sales outlook in world markets, investment activity over the forecast period looks set to pick up slowly. Favourable financing conditions will therefore continue to impact the economy. Construction activity will be supported by the favourable investment environment, and especially low interest rates.

Overall, gross domestic product is expected to increase by 0.4 percent this year (68 percent projection interval: 0.2 to 0.6 percent). The low average annual increase is mainly due to significant declines in production in the winter half year of 2012/2013. Gross domestic product is expected to increase by 1.8 percent in the year ahead (68 percent projection interval: 0.6 to 3.0 percent). The German economy will expand faster than production potential in 2014 and the capacity utilisation rate is expected to increase significantly.

The upward development in prices is expected remain moderate during the forecasting period, with inflation rates of 1.6 percent in this year and 1.9 percent in the year ahead. The number of employed persons is expected to increase by 235,000 persons on average this year, and by 260,000 persons in 2014. Since, however, the size of the potential workforce is increasing, this will not be reflected in any significant decrease in unemployment. The unemployment looks set to decline only slightly from 6.9 percent in 2013 to 6.8 percent in 2014.

The total public budget will close the year with a surplus of around 3 billion euros, or 0.1 percent of gross domestic product. Next year this surplus will rise to almost 8 billion euros, or 0.3 percent of gross domestic product as the economic situation improves. This forecast is based on the budget and finance plans as they currently stand.

Risks for the German economy primarily lie in the fact that the situation in the euro area remains fragile and the possibility that the crisis may flare up again cannot be excluded. The instruments created in recent years to stabilize the financial markets, and the European Central bank’s announcement of its willingness to intervene, under specific conditions, in the government bonds market in order to stabilise it, have only calmed down the situation temporarily, but do not represent a long-term solution. Any relaxation of political efforts to build a sustainable framework for European Monetary Union, or any abate in the consolidation and reform efforts in the crisis-afflicted countries could result in renewed tensions in the financial markets.

Important decisions are waiting to be taken in German economic policy in autumn 2013. Since the German Bundestag elections did not yield any clear majority, the course to be pursued by the future government will only emerge over the weeks ahead. This forecast was made based on economic policy under status quo conditions. During the election campaign, however, many proposals were put forward which – should they be implemented – would bring changes to economic, financial and social policy. These changes would involve both distribution issues, as well as the promotion of economic growth.

Financial policy in recent years has attempted to consolidate the public budget and has therefore created a favourable economic situation. In 2012 Germany presented a structurally almost balanced budget for the first time since 2000 and this will also apply to 2013. Based on the assumption that the increase in public spending will be very limited in the mid-term and that there will be no changes to tax rules, the government surplus will increase considerably to reach 1½ percent of nominal gross domestic product by 2018. Part of this surplus, however, is subject to cyclical considerations and should be used to pay off debts, as stipulated in principle by the German debt brake. The cyclically-adjusted public sector balance will be 1 percent of nominal gross domestic product in 2018. This corresponds to 33 billion euros. This amount represents the budgetary scope enjoyed by financial policy, without the need to raise taxes.

Financial policy should put the budget surplus to good use. It could be used to reduce “cold” progression in income tax (i.e., increasing burden on the taxpayers who are shifted by inflation into higher tax brackets) and to make investments in the fields of infrastructure, education and research. Additional scope could be created by eliminating subsidies.

With its announcement that it would defend the euro with all of the resources at its disposal, the ECB calmed down the situation in the financial markets and created a breathing space for economic policy. Its intervention, however, may possibly have had negative effects on the intensity of reform processes, by lessening pressure from the financial markets.

With its monetary policy the ECB reacted to the subdued developments in money and credit growth and dropped the interest rate for Eurosystem main financing operations by 25 points to 0.5 percent on 2 May 2013. However, the limits of expansive monetary policy in the euro area are now emerging. There will be no further noticeable stabilising impulses for the economy from further interest rate decreases in the crisis-afflicted countries, because the problems in their banking sectors have not yet been resolved. The institutes see a clean-up of these banking sectors as the key to an economic recovery. The owners and creditors of the banks should be called upon in the first instance, and in exceptional cases deposit holders beyond the limit of deposit protection. The national states would subsequently have to accept responsibility for the remaining old liabilities. A limited form of European burden-sharing should only be a last resort.

Source: http://www.internationaltradenews.com/en/news/46922/Economy-picking-up-Put-budget-surpluses-to-good-use.html
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Joint Economic Forecast Autumn 2013: Economy Picking up – Put Budget Surpluses to Good Use
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