ifo Economic Forecast Winter 2022: Inflation and Recession

The German economy is suffering from huge supply shocks. Bottlenecks in energy, intermediate products, and labor are weighing on production and driving inflation to record highs. Price pressure is not expected to ease until 2024, and then only slowly. Gross domestic product will contract in the 2022–23 winter half-year, pushing the German economy into recession. From spring 2023 onward, the economy should then recover and grow at stronger rates in the second half of the year, when incomes will again rise more strongly than prices. All in all, GDP will increase by 1.8% this year and contract slightly by 0.1% next year. In 2024, growth will then be back up to 1.6%.

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German Economy Suffers from Supply Shocks

Energy supply bottlenecks, difficulties in the supply of raw materials, intermediate products and merchandise, a worsening labor shortage – all this is putting a strain on the production of goods and services in nearly every sector of Germany’s economy. This not only limits production possibilities, but also drives up production costs as a result of supply-side shortages. At the same time, demand for goods and services is still strong. Overall, the companies surveyed by the ifo Institute say that production capacity of the German economy, which has been reduced by the supply shocks, has thus been pushed to its limits since the beginning of the year. As a result, prices not only rose because energy, raw materials, and intermediate products (most of which Germany imports from abroad) became noticeably more expensive. An additional factor in some sectors of the economy is that high demand enabled corporate profits to expand.

Rate of Inflation Declining

Inflation is expected to fall in the coming months. This will be ensured by the German government’s electricity and gas price brakes, which will take effect as of December. Nevertheless, domestic inflationary pressure will remain high for some time. On the one hand, demand for goods and services will continue to be supported in the coming year, not least as a result of the broad-based government relief packages. On the other hand, high collective wage settlements are likely to noticeably increase both purchasing power and wage costs. Overall, inflation is expected to fall from 7.8% this year to 6.4% next year. By contrast, core inflation is expected to rise from 4.8% to 5.8%.

Economic Development Shaped by Different Forces

The high inflation of consumer prices will reduce the real disposable incomes of private households, especially in the winter half-year, thus cooling consumer spending. It is not until the second half of the year that incomes are expected to increase more strongly than prices, and private consumption is therefore likely to pick up. Construction activity will also continue to cool. High construction prices and rising interest rates are causing demand for construction services to slump. Thanks to high order backlogs, the manufacturing sector should continue to expand its output moderately and then significantly more strongly again as the supply bottlenecks gradually disappear.

Taken together, overall economic output will fall by 0.3% and 0.4% quarter on quarter in the two quarters of the 2022–23 winter half-year. The German economy will thus technically be in a recession. Starting in spring 2023, the economy is expected to recover and grow at stronger rates in the second half of the year. All in all, GDP will increase by 1.8% this year and contract slightly by 0.1% next year. In 2024, growth will then be back up to 1.6%.

“The third quarter of 2022 in particular was much better than expected, with +0.4%. In the two quarters of the 2022–23 winter half-year, gross domestic product will shrink, but after that things will start to pick up again.”

Prof. Dr. Timo Wollmershäuser, Deputy Director of the ifo Center for Macroeconomics and Surveys and Head of Forecasts

Economic Slowdown Leaves Its Mark on the Labor Market

Employment growth is expected to come to a virtual standstill in the coming months and to pick up only slowly over the rest of the forecast period. As a result, the increase in the number of people in employment is likely to slow from around 554,000 in 2022 to 77,000 in 2023 and 80,000 in 2024. Unemployment is expected to rise by 84,000 next year and fall again by 117,000 in 2024. As a result, the unemployment rate in 2023 and 2024 is forecast to be 5.5% and 5.3%, respectively, after 5.3% in the current year. Short-time work is also likely to expand again temporarily in the winter half-year.

Expansionary Fiscal Policy

Fiscal policy is clearly expansionary this year and especially next year. As a result of the numerous relief packages, the government’s financing deficit will increase significantly from EUR 68 billion, or 1.8% of nominal GDP this year, to EUR 104 billion, or 2.6% of GDP next year. With the expiration of the price brakes in 2024, fiscal policy will then become restrictive and the deficit will fall to EUR 50 billion, or 1.2% of GDP.

Monetary Policy Tries to Tame Record Inflation

The European Central Bank (ECB) recently responded to the persistently high inflation rates in the euro area with substantial hikes in the key interest rate. Further interest rate increases will probably follow in the coming months, but these are likely to be somewhat weaker than recent ones. The interest rate for main refinancing operations is expected to rise to 4.0% by mid-2023. In line with the weakening inflation rate, key interest rates are then expected to fall again slightly by around 50 basis points in 2024, moving toward neutral. Credit and capital market interest rates will align with these developments, and the yield on ten-year German government bonds is expected to rise to around 3.5% by the middle of next year.

Key Forecast Figures for Germany

	2021	2022	2023	2024
Gross domestic product (percentage change over previous year)	2.6	1.8	-0,1	1.6
Employment (1,000 persons)	44980	45534	45611	45692
Unemployment (1,000 persons)	2613	2420	2503	2386
Unemployment rate (in % of civilian labor force)	5.7	5.3	5.5	5.3
Consumer prices (percentage change over previous year)	3.1	7.8	6.4	2.8
General government financial balance	2021	2022	2023	2024
- EUR billion	-134.3	-68.1	-104.1	-49.7
- in % of GDP	-3.7	-1.8	-2.6	-1.2
Balance on current account	2021	2022	2023	2024
- EUR billion	265.0	139.1	122.9	165.9
- in % of GDP	7.4	3.6	3.1	4.0

Source: Federal Statistical Office; Federal Employment Agency; Deutsche Bundesbank; 2022 to 2024: forecast by the ifo Institute.
© ifo Institute Dec. 2022

Infographic, Gross domestic product in Germany

Euro Area and the Global Economy

In the euro area, price-adjusted GDP will shrink in the 2022–23 winter half-year before recovering slightly. Annual growth is therefore low at 0.6% in 2023 and won’t increase until the following year (+1.7%). On the supply side, bottlenecks in the supply of energy, raw materials, and intermediate products and the associated high costs are restricting production, especially in energy-intensive sectors of the economy. On the demand side, high inflation in particular is reducing real incomes and dampening household consumption despite considerable support from fiscal policy. At the same time, slowing export market growth and rising interest rates are weighing on private investment. With public investment growing strongly in 2023 and inflation gradually declining as commodity prices stabilize, quarterly real income growth and economic activity should pick up in 2023 and 2024. However, the recovery could remain modest as support measures related to the energy crisis are slowly phased out, despite energy prices remaining exceptionally high, and the impact of higher real interest rates on economic activity becomes more pronounced.

In the United States, growth is expected to decline from 1.9% in 2022 to 0.9% in 2023 before rebounding to 1.5% in 2024. Declining real disposable income continues to affect consumer demand, and higher interest rates are dampening investment. Business surveys point to a further weakening of industrial activity, which is likely to have an increasingly negative impact on equipment investment, after construction investment (especially in housing) has already been declining for some time. In 2023 in particular, this is likely to gradually have a stronger impact on the labor market and ultimately curb wage growth. Inflationary pressure will therefore gradually weaken in the coming year, also helped by lower energy prices.

In China, the expected gradual lifting of strict regulatory restrictions to curb the spread of Covid-19 infections will have a positive impact on the economy over the forecast period. Although the normalization process will still take some time, it will lead to a noticeably higher expansion of the overall economy in 2023. Government spending, particularly on infrastructure projects, will support the economy. Monetary policy is also providing expansionary impetus, especially as – unlike most advanced economies – monetary policy in China is tending toward being eased after being tightened the previous year in the wake of the real estate boom. After growth of 3.4% in 2022, price-adjusted GDP is expected to increase by 4.5% and 4.8% in the following years.

Overall, following an increase of 2.8% in the current year, the world’s gross domestic product will expand by 1.6% in 2023 and by 2.6% in 2024. After a slight decline in the coming year (−0.5%), world trade will grow again in 2024 at roughly the same rate (+4.0%) as in 2022.