Euro Crisis Curbs Economic Activity – Risks to Stability Remain High
Joint Economic Forecast Autumn 2012:Euro Crisis Curbs Economic Activity – Risks to Stability Remain High Press version Embargo until: Thursday, 11 October 2012, 11.00 a.m. CEST Joint Economic Forecast Project Group Completed in Kiel on 9 October 2012
Euro Crisis Curbs Economic Activity – Risks to Stability Remain HighThe euro crisis is putting a strain on the German economy. Economic growth will there-fore remain weak for the moment and only looks set to recover again slightly over thecourse of next year. The institutes forecast a 0.8% increase in gross domestic product for2012 and a 1.0% increase for 2013. The situation in the employment market will deterio-rate further, with the number of unemployed set to rise slightly to 2.9 million in 2013.The German state budget will be almost balanced both this year and in 2013. The insti-tutes are critical of the ECB’s programme to purchase the government bonds of crisiscountries. This will increase the danger of inflation.The world economy is going through a weak phase in autumn 2012. Economic activity has lostmomentum nearly everywhere and the mood among companies and households has deteriorat-ed further. A key factor stress factor since last year has been the debt and confidence crisis inthe Eurozone. In addition, adjustment processes that have been taking place ever since thereal-estate bubble burst in 2007 in the USA and in other advanced economies, have not yetbeen completed. The consequences of structural faults pre-dating the crisis are continuing tocurb economic activity; and the longer it takes for a real recovery to occur, the more awarecompanies, households and governments become that the long-term growth and income per-spectives are worse than previously imagined.In late summer the central banks in the large, advanced economies reacted to the recent surgein pessimism in the financial markets and the deterioration in the economic outlook by an-nouncing new government bond purchases, unlimited this time in the case of the ECB and theFed. The mood in the financial markets initially brightened as a result. However, it is ques-tionable whether monetary policy can succeed in reviving economic activity in this way. TheECB´s chances of sustainably improving the financing conditions for public and private debt-ors in the crisis countries will largely depend on whether economic policy can restore the con-fidence of financial investors, companies and households in the reform and consolidation ef-forts undertaken in the Eurozone. In this case fiscal policy will – as in almost all other ad-vanced economies - have a strong dampening effect. However, it nevertheless offers the per-spective that the uncertainty currently crippling economic activity in the crisis countries willsubside.Based on this assumption, economic activity in the Eurozone should gradually stabilise. Aftera downturn of 0.5% this year, gross domestic product will do little more than stagnate nextyear. In the USA demand will be curbed by highly restrictive fiscal policy next year. Macroe-
conomic output in advanced economies should therefore only increase very slightly and at arate of 1.2%. In the emerging markets economic growth should accelerate somewhat nextyear. In the case of China in particular, it is safe to assume that the government will continueto follow its recent course and will upscale the expansionary character of its policy until eco-nomic activity clearly starts to pick up again. Overall, the world economy will grow relativelyslowly up until the end of 2013; world output looks set to increase by 2.3% this year and 2.5%next year. World trade is expected to pick up only a little during this time. After growth of just2.1% this year, it is also expected to increase at a long-term, moderate pace of 3.8% in theforthcoming year.The euro crisis is also negatively impacting economic activity in Germany. In spring 2012fresh problems in the crisis countries triggered turbulence in the financial markets, and uncer-tainty regarding the future of the Eurozone increased again. Combined with the deteriorationin the world economy, this hit the confidence of companies in Germany. Business expectationshave deteriorated from month to month since April 2012 accordingly and recently fell to theirlowest level since the recession of 2008/2009. The unfavourable outlook had a particularlynegative impact on corporate investment.German exports, on the other hand, have been able to hold their ground very well given thedeteriorating world economic climate. German exporters are obviously profiting from the factthat their price competitiveness improved significantly up lately due to the depreciation of theeuro. Recently the euro was as cheap as it has ever been since the foundation of the EuropeanMonetary Union.There are currently a large number of signs that overall economic expansion will weaken to-wards the end of the year. Order intake in manufacturing has followed a downward trend re-cently, and the unfavourable expectations of companies suggest that investments in equipmentand commercial construction will continue to fall. Investments in residential property, on theother hand, remain attractive. Overall, the institutes expect real gross domestic product to in-crease by 0.8% in 2012.Over the course of the year ahead economic activity in Germany is expected to improve, sincethe situation in the Eurozone should gradually ease and the rest of the world economy shouldgain greater momentum. In this improved environment favourable financing conditions will
have a greater impact. In the second half of next year the increase in gross domestic productonce again looks set to be higher than the growth rate of potential output, which the institutesassess at slightly above 1%. They nevertheless expect an annual average increase in gross do-mestic product of just 1.0% Key Forecast Figures for the Federal Republic of Germany 2008 2009 2010 2011 2012 2013 Gross domestic product (GDP) (% change on previous year) 1,1 –5,1 4,2 3,0 0,8 1,0 Employment a) (1,000 persons) 40 348 40 370 40 603 41 164 41 627 41 775 Unemployment (1,000 persons) 3 258 3 415 3 238 2 976 2 892 2 903 Unemployment rate b) (in %) 7,8 8,1 7,7 7,1 6,8 6,8 Consumer prices c) (% change versus previous year) 2,6 0,3 1,1 2,3 2,0 2,1 Unit labour costs d) (% change versus previous year) 2,3 6,2 –1,5 1,2 2,8 1,8 General government financial balance e) in EUR billion –1,8 –73,0 –103,6 –19,7 2,0 –0,2 as % of GDP –0,1 –3,1 –4,1 –0,8 0,1 0,0 Balance of Current Accounts in EUR billion 153,6 140,6 150,7 146,6 166,7 166,5 as % of nominal GDP 6,2 5,9 6,0 5,7 6,3 6,1 a) Nationally. – b) Unemployed as % of civil working population (definition according to the Federal Employment Agency). – c) Consum- er price index (2005 = 100). – d) National employed compensation per worker in relation to real domestic product per employed person – e) compiled on a national accounts basis (ESA 1995).Sources: Federal Statistical Office, Federal Employment Agency, German Bundesbank; 2012 and 2013: forecast of the Institutes. JF Autumn 2012In view of the overall economic development forecast, the situation in the employment marketis expected to recover very little for the moment. The rise in employment has already sloweddown considerably in the course of this year. There has even been a slightly upward trend inunemployment since the spring, not least due to the fact that the size of the potential workforceis increasing more quickly due to greater immigration. Factors like the falling number of jobsvacant since the beginning of year suggest that labour demand is hardly expected to increase inthe forecasting period. The unemployment rate is expected to be 6.8% in both years of theperiod.Despite weakening economic activity, the increase in consumer prices over the course of 2012slowed only slightly. Inflation has even accelerated slightly again recently due to rising crudeoil prices. The institutes expect domestic price inflation to grow during the forecasting period.The rise in unit labour costs in particular is expected to accelerate. Overall, an inflation of rateof 2.0% is forecast for this year and a rate of 2.1% for next year.For public finances it is significant that the structure of economic expansion is currently verymuch characterised by expenses, since gross wages and salaries and nominal private consumer
spending are increasing considerably. This has strongly boosted state income until recently.Moreover fiscal policy is restrictively–oriented this year. Against this background the insti-tutes expect the budget for 2012 to be balanced. There should not be any further improvementsin the budget situation next year, especially since consolidation is expected to be interrupted.This assessment of the German economy is based on the assumption that the situation in theEurozone gradually stabilises over the forecasting period and that confidence, especially onthe part of investors, is restored. Should the situation in the Eurozone continue to deteriorate,this will also impact the German economy. Over the forecasting period as a whole the down-side risks prevail and there is a great danger that Germany will fall into a recession.The euro crisis will continue to determine economic policy. At the beginning of September theECB Council decided to purchase government bonds in the secondary market under certainconditions and on an unlimited basis in principle. There are nevertheless no signs of a long-term economic policy solution to the crisis; on the contrary, risks to stability remain high.To overcome the government debt crisis it is necessary to guarantee the sustainability of pub-lic finances in the crisis countries. Should this sustainability be endangered, then a state hasfour possibilities in principle. The first is to consolidate its budget and enable higher growththrough structural reform. Should this fail, a state is left with three options: its public debt canbe carried by others through transfers, it can be reduced through insolvency or restructuring, orit can be devalued via inflation. Ultimately, Europe’s economic policy-making bodies are alsonow confronted with this choice.According to the institutes, the strategy of reforms promoting growth linked with the credibleconsolidation of public budgets remains the best way of restoring confidence in the sustaina-bility of public finances in the crisis countries. Moreover, in recent months there has beengrowing doubt as to whether this strategy alone will produce the desired result. At the sametime, domestic political debates in countries like Finland and Germany have shown that thereadiness to increase assistance loans or make transfers is evaporating. This makes a transfersolution less likely.The option of a state declaring insolvency is categorically excluded by politicians. This meansthat there is no ordered, fiscal policy alternative should the growth and consolidation strategy
should fail. Yet insolvency would be an appropriate way of making creditors share the costs ofthe crisis. This should take place in the framework of an insolvency mechanism for states,which has been called for by the institutes on several occasions in previous expert reports.In the absence of another politically acceptable solution, the ECB has now intervened onceagain to limit the risk premiums for the government bonds of crisis countries. The ECB’s deci-sion could shake the main pillar of the currency union, namely the goal of price stability. Dueto these conditions the ECB is no longer independent of fiscal policy, blurring the responsibili-ties for individual policy areas. Yet a central bank’s independence is a key requisite for a long-term, stability-oriented monetary policy.Against this background the institutes are also critical of the WTO programme. They see therisk of a mid-term rise in inflation. This process could be triggered by the ECB effectivelyproviding monetary financing for states. Europe’s citizens and players in the markets may losetrust in the ECB’s ability to ensure long-term price stability as a result. Sooner or later infla-tion expectations will then be cut loose. In the longer-term there is a great danger that the ECBwill continue to purchase bonds and provide excessive monetary policy stimulation even ifstates deviate from the adjustment programmes, which could drive up prices and lead to anincrease in inflation expectations. Since rebuilding a monetary-policy reputation can be alengthy process in such cases and is accompanied by restrictive impulses, guaranteeing pricestability would have high social costs.Independent of the central bank’s current course, a lasting expansive monetary policy mayhave major implications for economic development in Germany in the mid-term. Althoughthere is no overheating at the moment, a shortage of capacity can nevertheless be expected inthe mid-term. This creates the risk of excesses in, for example, the real-estate sector. However,debt-financed excesses on the scale witnessed in some of the crisis countries in the Eurozoneseem unlikely at the moment in Germany. Moreover, banks in Germany traditionally haverelatively strict requirements for granting credit. However, this does not rule out the possibilityof excesses in the mid-term, especially in the real-estate sector. Economic policy should fol-low this closely and can use a series of indicators analysed in the expert report as a point oforientation. Since economic excesses follow similar patterns, but are never absolutely identi-cal, a broad spectrum of indicators should be used.