Joint Economic Report Autumn 2012: Economic Slowdown due to Euro Crisis – Stability Risks Remain High
ResearchThe euro crisis is putting a strain on the German economy. Economic growth will thus remain weak in the near future and will not improve until next year. The institutes forecast an increase of GDP by 0.8 per cent in 2012 and by 1.0 per cent in 2013. The situation on the labour market will worsen; the number of unemployed persons will increase slightly in 2013 to 2.9 million. The national budget will be nearly balanced in 2012 as well as in 2013. The institutes take a critical stance to the ECB initiative to purchase sovereign bonds of struggling countries. According to the institutes, the ECB programme fuels the risk of inflation.
In autumn 2012, the global economy is in a phase of weak growth. The economy has lost its momentum nearly everywhere and the sentiment of companies and households has further deteriorated. The debt and confidence crisis within the eurozone has already been a central burdening factor since 2011. In addition, the burst of the housing bubble in the United States in 2007 has triggered adjustment processes which are also taking place in other advanced economies and have not yet been concluded. The results of structural errors prior to the beginning of the crisis still weaken the economy. The longer a general recovery takes, the more companies, private households, and governments reach the conclusion that the long-term prospects on growth and incomes are worse than they had believed until now.
In late summer, the central banks of the major developed economies responded to the increasing pessimism on the financial markets and the tarnishing economic outlooks by announcing bond purchases. The ECB and the Fed launched unlimited bond buying programmes. After the announcement of these programmes, the sentiment on the financial markets improved. However, it is unlikely that these monetary policy efforts will successfully stimulate the economy on the long run. If the ECB will be able to improve funding conditions for public and private debtors largely depends on whether the confidence of financial investors, companies, and households in the reform and consolidation efforts within the eurozone can be restored. In this case, financial policy will have a strong dampening effect, like in most developed economies. However, there is a chance that the uncertainty that is currently paralysing the economic activities in the struggling countries will thus be reduced.
Under these conditions the eurozone’s economy is likely to gradually stabilise. After this year’s decrease by 0.5 per cent, GDP will largely stagnate in the coming year. A highly restrictive financial policy will dampen market demand in the U.S. in 2013. The overall economic output of the developed national economies is likely to increase at a rate of only 1.2 per cent in both years. The economic growth of emerging countries is expected to accelerate slightly next year. Especially China’s government will probably stick to its policy of growth incentives until the economy starts picking up substantially. All in all, the global economy will grow slowly until the end of next year; global production is expected to increase by 2.3 per cent in 2012 and by 2.5 per cent in 2013. World trade is only slightly stimulated. After an increase by only 2.1 per cent throughout this year, it will increase at a rate of 3.8 per cent next year, which is a rather moderate speed in a longer-term context.
The euro crisis is affecting the German economy as well. Last spring, new problems in the troubled countries caused turbulences on the financial markets, and the uncertainty about the eurozone’s future rose again. Along with the tarnishing global economy, this uncertainty put a strain on the confidence of companies in Germany. Since April 2012, for instance, business expectations have been deteriorating month by month and have recently reached the lowest level since the recession in 2008-09. These unfavourable prospects particularly affected business investments.
German exports, however, have generally remained firm in the face of the deteriorating global economic situation. German exporters apparently benefited from the depreciation of the euro. They were able to significantly improve their price competitiveness, which has never been stronger since the foundation of the European Monetary Union.
Today, indications clearly point toward a slowdown of the overall economic expansion by the end of 2012. The volume of incoming orders in the manufacturing industry, for example, continues to decline, and the unfavourable expectations of companies indicate a further decline of investments in infrastructureand commercial constructions. Investment in residential property, on the other hand, is apparently still an attractive option. All in all, the institutes expect an increase of the real GDP by 0.8 per cent in 2012.
In the course of the coming year, the German economy is likely to brighten up as the situation in the eurozone will arguably ease and the global economy will likely pick up speed. In such an improved context, a positive impact of favourable financing conditions is expected. In the second half of the coming year, GDP growth will presumably exceed the growth rate of potential output, which the institutes expect to be at slightly more than 1 per cent. Nonetheless, the institutes estimate an annual average GDP growth of 1.0 per cent.
In the context of the expected overall economic development, no further improvement on the labour market is foreseeable. The rise in total employment has already slowed down noticeably throughout this year. Unemployment has even been increasing since spring. One of the reasons for this development is that the labour force potential is growing faster, which is partly due to increased immigration. In the forecast period, labour demand will barely rise, as indicated by the shrinking number of vacant positions. The unemployment rate will be 6.8 per cent during both years of the forecast period.
Despite the weakening economy, the increase in consumer prices hardly slowed down in 2012. Due to rising crude oil prices, inflation even picked up again. The institutes expect an increasing domestic inflation during the forecast period. Especially unit labour costs grow faster. All in all, inflation rates of 2.0 per cent in 2012 and 2.1 per cent in 2013 can be expected.
An important aspect of the development of public finances is that the current macroeconomic expansion structure is generating a huge amount of duties and taxes, because gross wages and private consumption grow noticeably. Consequently, government revenues increased significantly. In addition, financial policy is restrictive this year. Against this background, the institutes expect a balanced national budget. In the coming year the budget situation is not likely to improve, particularly as the austerity policy will arguably not be continued.
This assessment of the German economy is based on the assumption that the situation in the eurozone will gradually stabilise and investors’ confidence will be restored over the period of the report. This assumption, however, is by no means certain. If the situation in the eurozone continues deteriorating, the German economy will be affected as well. Downside risks prevail throughout the entire forecast period and there is a great danger that even Germany will fall into a recession.
Economic policy is still determined by the euro crisis. At the beginning of September, the ECB Governing Council launched a programme allowing the institution to purchase an unlimited volume of sovereign bonds under specific conditions. However, there is no sign of a long-term solution to the crisis; in fact, stability risks remain high.
It is necessary to safeguard the sustainability of public finances within the troubled countries to tackle the sovereign debt crisis. Generally, a state has four options if its financial viability is at risk. The first one is to consolidate its budget and to stimulate higher growth rates through structural reforms. If these measures are not successful, three options remain: the public debt can be shouldered by others through transfers, it can be reduced by insolvency or restructuring, or it can be devaluated through inflation. In the end, economic policy-makers in Europe do have to make a choice between these options.
According to the institutes, a combination of reforms supporting economic growth and credible efforts to consolidate the national budget is the ideal strategy to restore confidence in the sustainability of public finances. In the last months, however, more and more doubts were raised if this strategy alone leads to the desired result. At the same time, internal political debates in countries like Finland and Germany made clear that the willingness to increase aid packages or to provide transfer payments is shrinking. A a solution by means of transfer payments therefore becomes less likely.
The option of national insolvency has been excluded categorically by policy-makers. In consequence, there is no regular financial policy alternative if the growth and consolidation strategy fails to succeed, although this would be an appropriate way to include creditors when it comes to the costs of the crisis. This should be done within the framework of an insolvency mechanism for states, which the institutes had demanded repeatedly in previous reports.
For want of any other politically accepted solution, the European Central Bank stepped in again to limit the risk premium for sovereign bonds of troubled countries. The cornerstone of the Monetary Union, the goal of price stability, could be at risk as a consequence of the ECB strategy. Due to the conditionality of its programme, the ECB is no longer independent of financial policy, thereby blurring the responsibilities between the separate policy areas. The independence of a central bank, however, is an important long-term condition for a stability-oriented monetary policy.
Against this background, the institutes take a critical stance to the Outright Monetary Transactions (OMT) programme by the ECB . They identify a growing inflation risk on the mid-term. This development could be initiated by the ECB’s de facto monetary state financing. In consequence, citizens as well as financial market players could lose confidence in the ECB’s capacity to guarantee long-term price stability. Sooner or later, the expectations on inflation could become detached from their anchorage. Besides, there is a high risk that the ECB would still purchase bonds even if the troubled countries deviate from the adjustment programmes, and that it excessively stimulates with regard to monetary policy. This might result in increasing prices and could trigger an increase of inflation expectations. Since there would then be a long way to go before the monetary reputation could be regained, and because this path would involve restrictive impulses, the safeguarding of price stability would be associated with severe social costs.
Regardless of the Central Bank’s current course, an on-going expansive monetary policy may have considerable consequences for the mid-term economic development in Germany. Although the German economy is currently not overheating, a shortage of capacities can be expected on the mid-term. Germany is thus facing the risk of overstimulation, for example on the real estate market. A debt-financed overstimulation of an extent comparable to some of the countries which are now in the centre of the crisis is currently not very likely for Germany. Moreover, bank lending is traditionally tied to comparably strict conditions in Germany. By no means, however, do these factors eliminate the risk of sectoral excessive valuations, especially within the real estate sector. Economic policy should pay great attention to these developments. A number of indicators, which are analysed within this report, could serve as orientation guides. Since economic overstimulation processes develop along similar patterns, but are never completely identical, a broad range of indicators should be considered.
Joint Economic Forecast Group consists of:
ifo Leibniz Institute for Economic Research at the University of Munich
KOF Konjunkturforschungsstelle at ETH Zurich (Business Cycle Research)
Kiel Institute for the World Economy
for the medium-term forecast in co-operation with:
Centre for European Economic Research (ZEW) Mannheim
Institut for Economic Research Halle
Institute for Advanced Studies, Vienna
For further information please contact
Dr. Marcus Kappler, Phone +49 621/1235-157, E-mail kappler@zew.de