ifo Economic Forecast Winter 2023: Economic Recovery Delayed – Budget Gap Harbors New Risks

The course for the German economy has been set for recovery. Inflation is declining further, wage income is rising at strong rates, and employment is higher than ever before in reunified Germany. This means that purchasing power is returning and overall economic demand should pick up again. Price-adjusted gross domestic product (GDP) is expected to rise by 0.9% next year, following a decline of 0.3% this year. The economy should then normalize in 2025. Price-adjusted GDP is likely to increase by 1.3% compared to the previous year.

Content

German Economy Is Treading Water

Over the course of this year, the inflation rate has eased and the increase in wage income has accelerated compared to the previous year. However, the recovery in private consumption has so far failed to materialize, partly because people have chosen to put some of the increase in purchasing power into savings. Global trade in goods and global industrial production have also failed to provide a boost. Central banks dampened the economy in many places to combat inflation, and in the course of the recovery from the coronavirus crisis, services in particular were on the upswing worldwide. German exports therefore continued their downward slide until just recently. The only strong expansionary momentum came from government investment. The procurement of armaments from the special fund for the German Armed Forces is particularly noticeable here. Overall, the economy has cooled noticeably since the beginning of the year, and the recovery that was originally expected in the second half of the year did not occur.

Inflation Declining

The course for recovery has essentially been set in the forecast period. Inflation continues to decline, which means interest rates are likely to have peaked. Capital market and lending rates have been falling since the beginning of November, and the European Central Bank will probably decide to make an initial cut to key interest rates in the early summer of next year. This should also support the German sales markets, especially as purchasing power is also expected to increase there. Global trade in goods and the consumption of goods should therefore increase again and become the drivers of the economy in the coming year. Overall, however, the end of the year is still likely to be weak, and the mood among private households and companies is poor. Nevertheless, the declines of recent months have not continued and slight improvements have been recorded in many areas.

“Die Weichen sind auf Erholung gestellt, doch die Haushaltslücke birgt neue Risiken für die deutsche Wirtschaft im kommenden Jahr.”

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

Only a Slow Economic Recovery

All in all, overall economic output in the current quarter will probably do nothing more than stagnate. From next year onward, the economy is expected to gradually recover and grow at a stronger rate. This means that price-adjusted GDP will fall by 0.3% this year and increase by 0.9% next year. Compared to the ifo economic forecast from fall 2023, the growth rate for the current year has thus been raised by 0.1 percentage points and lowered by 0.5 percentage points for the coming year.

The growth rates for the current and coming quarters have been lowered, thereby reducing the pace of recovery. The economy should then normalize in 2025. Price-adjusted GDP is likely to increase by 1.3% compared to the previous year, 0.1 percentage points more than expected in the fall. This should close the gap to production potential by the end of the forecast period.

Labor Market

The economic slump will also leave its mark on the labor market. Employment is likely to stagnate in the winter half-year before rising again slightly from spring onwards as part of the recovery. On an annual average, the increase in the number of people in employment is likely to slow from 353,000 this year and 83,000 next year to 9,000 in 2025. Unemployment is expected to rise by 191,000 people this year and by a further 82,000 people next year. A decrease of 113,000 is expected in 2025. As a result, the unemployment rate in 2024 and 2025 is expected to be 5.9% and 5.6% respectively, after 5.7% in the current year.

Fiscal Policy

Germany’s fiscal policy is again slightly expansionary in the current year. The main drivers for this are measures in connection with combating the energy crisis. The fiscal policy course for the next two years is subject to a high degree of uncertainty. This forecast is based on the assumption that all previously planned fiscal policy measures will be implemented regardless of the budget gap. This means that fiscal policy is likely to take a slightly restrictive course, as more measures will be dropped than new ones added. The government’s financing deficit will then fall from EUR 77 billion or 1.9% of nominal GDP in 2023 to EUR 48 billion or 1.1% of nominal GDP in 2025. The debt level according to the Maastricht criteria will fall from 64.3% this year to 63.1% of nominal GDP at the end of the forecast period.

If additional consolidation measures are adopted in order to set up a budget that complies with the German constitution, it is highly likely that the present forecast is too optimistic. According to estimates based on the ifo-DSGE model, consolidation measures amounting to EUR 20 billion, for example, are likely to be accompanied by a loss of growth of around 0.2 percentage points in the coming year. If the measures were implemented as assumed in the simulation, the increase in price-adjusted GDP would be only 0.7% in the coming year.

Graphic, ifo Economic Forecast Winter 2023, Germany

Key Economic Figures

Graphic, ifo Economic Forecast Winter 2023, Key Forecast Figures

Euro Area and the Global Economy

In the euro area, consumer demand from private households has weakened due to the less favorable development of real wages. In addition, the energy price shock of the previous year is still weighing on the industrial economy, particularly in the industry-heavy regions of Central Europe. Overall economic production remained largely unchanged from the fourth quarter of 2022 to the third quarter of 2023. Nevertheless, the labor markets in the euro area remain tense. The demographically induced labor shortage is driving up search costs and reducing companies’ recruitment opportunities, so companies are more likely to retain employees despite underutilization. The inflation rate recently fell rapidly to 2.4% in November 2023 and is therefore only just above the European Central Bank’s (ECB) target value.

In the euro area, growth in overall economic output is likely to accelerate from 0.5% in the current year to 1.0% in the coming year and 1.5% in 2025; this corresponds to a slight downward revision of 0.2 percentage points for 2024 and 0.1 percentage points for 2025.

Contrary to all expectations, the US economy is robust and consumer spending by private households continued to support demand in the third quarter. Fiscal policy is also extremely expansionary in the current year, with the overall budget deficit increasing from 4.0% of GDP in 2022 to 7.4% in 2023. Accordingly, the inflation rate remains above 3%.

In China, the structural real estate crisis is being masked by government stimulus measures, and economic growth accelerated in the third quarter. In contrast to most other economies, there has been no notable increase in consumer prices in China; in fact, prices have actually fallen.

All in all, global output growth is likely to fall from 2.7% in the current year to 2.0% in the coming year and 2.3% in 2025.