ifo Economic Forecast

ifo Economic Forecast Winter 2019: German Economy Stabilizes

The German economy stabilized in the third quarter of 2019. Overall, the average economic output for 2019 will expand by 0.5%; when adjusted for calendar effects, the growth is 0.6%. In the next year, gross domestic product will increase more strongly by 1.1%, although the calendar effect of 0.4 percentage points exaggerates the quite modest underlying business cycle dynamic. Economic momentum in the euro area is not expected to get any worse at this juncture, and it will take several quarters before there is a tangible recovery. Global output is expected to expand at average rates.


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German Economy Stabilizes

The German economy stabilized in the third quarter of 2019, after gross domestic product had fallen by 0.2% in the previous quarter. This stabilization was due to an increase in private consumption and the strong economic performance in the German construction sector. Albeit that employment growth has slowed down over the course of the year, income growth of private households has remained robust. Alongside an appreciable rise in collective wages, other factors – duty relief and an expansion of government transfer payments, such as pensions and child benefit – have also strengthened purchasing power. In addition, brisk public investment and consumption bolstered domestic demand. And lastly, mortgage interest rates fell sharply once again and the granting of housing loans gained momentum.

However, the German economy remains divided. Whereas the value added by service and construction companies that focus on the domestic market continues to rise, the manufacturing industry remains caught in recession. Its employment levels have been falling since spring this year, and the proportion of industrial companies that register short time work has risen sharply. One reason is the trade conflict pursued by the United States, which is hampering global trade and investment activity. This is hitting German industry particularly hard, as its production is specialized in intermediate and capital goods. Another reason can be found in the particular challenges facing the automotive sector, one of the key industries in Germany. In addition to general consumer reticence worldwide, which is reflected above all in declining new registration figures, the automotive industry is in a phase of technological transition to the production of vehicles with non-conventional engines. In the course of restructuring existing value chains, this transition leads to significant production losses and relocations.

“The German economy remains divided. Whereas the value added by service and construction companies that focus on the domestic market continues to rise, the manufacturing industry remains caught in recession.”

Prof. Dr. Timo Wollmershäuser, Head of Business Cycle Analysis and Forecasts

Spread of Industrial Weakness to Other Sectors Limited So Far

To date, the spread of industrial weakness has been limited to industry-oriented service providers, whose value added and employment are falling due to a lack of orders. As yet, there has been no indirect transmission to consumer- and construction-related economic sectors via the labor market. A likely contributing factor is the expedient of short-time work, which over 10% of industrial companies are now expected to have made use of and which stabilizes employees’ incomes. And finally, strong employment growth in the public sector also contributed to the economic stabilization.

Overall, the German economy has cooled significantly in the last twelve months. Shortages in production capacity from the boom years of 2017/2018 have been largely resolved, resulting in capacity utilization that roughly corresponds at present to the long-term average. One of the main drivers of the slowdown is supply-side changes in the German economy’s production technology. By contrast, domestic demand is increasing steadily. This distinguishes the present downturn from that of the years 2011 to 2013; back then, Germany was caught up in the euro crisis and went into a general economic recession, in which the value added by domestic-focused economic sectors also fell.

No Cause to Fear an Economy-wide Recession

At present, there are no grounds to fear an economy-wide recession. Although value added in German industry will shrink further in the fourth quarter, the manufacturing sector should gradually leave its recessive phase behind over the remainder of the forecasting period. Uncertainty will remain high concerning the form Brexit will take, the further development of the trade conflict, and the consequences of the technological change in the automotive sector; however, the probability of a hard Brexit or of the US further escalating the trade conflict has decreased in recent months. Moreover, this forecast has been made on the assumption that German car manufacturers are successfully managing the transition to e-mobility and gradually ramping domestic production up again. The most recent order intake levels, the ifo business expectations in the manufacturing sector, and another increase in goods exports in October 2019 indicate that the free-fall has stopped and that gradually, light is emerging at the end of the industrial tunnel.

The industrial weakness is most apparent in corporate investment, which will probably at most stagnate in the winter half-year 2019. In the further course of the forecasting period, we should see a moderate expansion again. However, the continuing uncertainty should have a dampening effect on investment in equipment. When it comes to industrial construction investment, by contrast, we expect there to be not much in the way of impetus from the investment projects of Deutsche Bahn and the expansion of the broadband network. In 2021 in particular, moreover, the easing of the tax burden due to the partial abolition of the solidarity surcharge should have a stimulating effect.

Consumer and Construction Sectors Stabilize Overall Economy

In spite of the industrial weakness, the outlook for a continuation of the dynamic consumer economy remains bright. However, a slowing of private consumption can be seen in the current quarter. For example, recentprice-adjusted retail sales were well below the average value for the third quarter. In the remaining forecasting period, however, private consumption will be boosted by fiscal stimuli, which will counteract the slowdown in the growth of gross earned income. Investment in residential construction should also continue to increase strongly and remain a pillar of the German economy. However, indicators suggest that the boom of the current building cycle has already been passed and that the pace of expansion will slow down somewhat over the next two years.

The macroeconomic stabilization also becomes clear by considering the ifo Business Climate Germany, which has now risen slightly for the past three months in a row. As a result, another contraction of the economy would appear to be unlikely. In the final quarter of 2019, price-adjusted gross domestic product is expected to increase slightly by 0.1%. Overall, the average economic output for 2019 will expand by 0.5%; when adjusted for calendar effects, the growth is 0.6%. In the next year, gross domestic product will increase more strongly by 1.1%, although the calendar effect of 0.4 percentage points exaggerates the quite modest underlying business cycle dynamic. German industry will probably deliver a negative growth contribution to gross domestic product once again, although it should end up being much lower than in the current year. In 2021, gross domestic product is expected to expand at a rate of 1.5% and thus more strongly than production potential. Capacity utilization of the Germany economy is expected to increase again and end up being slightly positive at the end of the forecasting period.

Expansionary Fiscal Policy

One of the primary contributor to this upturn is fiscal policy, which will have an expansive effect in the current year and over the next two years by means of relief on taxation and social insurance contributions, an expansion of government transfer payments, and an increase in government consumption and public investment expenditure. Simulations reveal that the measures adopted by the German government should increase the average annual growth rate of real gross domestic product by 0.2 percentage points this year and by 0.3 percentage points in each of the next two years. Against this background and also as a result of weak economic performance, general government net lending will fall considerably in the forecasting period from around EUR 55 billion in 2019 and EUR 30 billion in 2020 to just over EUR 8 billion in 2021.

Employment growth is expected to continue at a dampened rate over the forecasting period. In particular, the willingness of companies in the manufacturing industry to hire new employees has worsened markedly. The reduction in the unemployment rate is also expected to continue at a noticeably curbed pace. The unemployment rate will be 5.0% this year and is expected to fall to 4.9% and 4.8% in the next two years respectively. The inflation rate is expected to rise from 1.4% this year to 1.6% in 2021. In addition to the recovering economy, which is giving many companies the leeway to raise prices, another contributing factor to the increase in inflation are rising electricity prices. The wages actually paid per employee are expected to have increased relatively strongly this year by 2.8%. Over the next two years, we expect few stimuli from collective bargaining negotiations for general economic reasons. As the labor shortage is expected to increase due to demographic reasons, we expect a positive wage drift again as the forecasting horizon advances. Overall, actual wages paid should rise by 2.5% in 2020 and by 2.7% in 2021.

Key Forecast Figures for Germany

  2018 2019 2020 2021
Gross domestic product (percentage change over previous year) 1.5 0.5 1.1 1.5
Employment (1 000 persons) 44,854 45,251 45,420 45,599
Unemployment (1 000 persons) 2,340 2,266 2,248 2,198
Unemployment rate (in % of civilian labor force) 5.2 5.0 4.9 4.8
Consumer prices (percentage change over previous year) 1.8 1.4 1.5 1.6
General government financial balance 2018 2019 2020 2021
 - EUR billion 62.4 55.0 30.5 8.9
 - in % of GDP 1.9 1.6 0.9 0.2
Balance on current account 2018 2019 2020 2021
 - EUR billion 246.0 252.0 271.0 276.0
 - in % of GDP 7.4 7.3 7.7 7.5

Source: Federal Statistical Office; Federal Employment Agency; Deutsche Bundesbank; 2019 to 2021: forecast by the ifo Institute.
© ifo Institute Dec. 2019

Real GDP in Germany - ifo Economic Forecast Winter 2019

Euro Area: Tangible Recovery Fails to Materialize

Economic momentum in the euro area remained below potential growth for the entire summer half-year. In particular, value added in the manufacturing industry declined. In contrast, consumer-related services and the construction sector   continue to expand robustly. However, the weak phase in manufacturing industry does not affect all countries and economic sectors equally. A country comparison shows that the sentiment is particularly gloomy in those places where capital and intermediate goods make up a large proportion of industrial production. This is particularly the case for Germany. By contrast, countries with comparatively high consumer goods production benefit from the robust consumer economy in many advanced economies. This applies particularly to France and Spain. Italy is a special case: its production activity has remained weak on account of structural problems. Since June of this year, the unemployment rate in the euro area has not fallen further and currently stands at 7.5%. Employment growth has also been weakening in the euro area since the end of 2018. This trend was driven primarily by manufacturing industry.

Although economic momentum in the euro area is not expected to get any worse at this juncture, and it will take several quarters before there is a tangible recovery. The uneven development in the various economic sectors is also expected to last a while longer. As the weak phase continues, it will increasingly impact the labor market in the form of a lower growth of employment and wages. This will have dampening effects also on the production of consumer goods and on consumer-related services. In many euro area countries, however, the economy is being supported by fiscal stimuli. Moreover, the probability of a hard Brexit or of the US further escalating the trade conflict has decreased in recent months. Overall, price-adjusted gross domestic product is predicted to increase by 1.2% both this year and next, followed by 1.3% in 2021. As a result, the output gap in the euro area is expected to fall and the capacity to be slightly underutilized at the end of the forecasting period. As a consequence of the economic slowdown, the overall unemployment rate in the euro area will level off this year at 7.6% and then fall in the next two years to 7.4% and 7.2%.

Real GDP in the Euro Area - ifo Economic Forecast Winter 2019

Global Economy: Prospects Stabilized

The world economy has cooled down further. Production in the manufacturing sector fell in the summer half-year, particularly in the advanced economies. In contrast to the industrial weakness, services and consumption are still robust, which are supported by strong wage increases. The capacity utilization in the global economy has been decreasing for some quarters and the  output gap was closed in the third quarter of 2019. There are two reasons for the weakness in the industrial sector and in global trade: One is the trade conflict between the US and China, which has strongly curtailed the exchange of goods between these countries and thus dampened production. The trade conflict has also affected other regions, as uncertainty has increased surrounding the continued existence of established international value chains, while the risk has also grown of being affected by new trade measures from the US. The second reason is that the demand for automobiles has fallen sharply in many places, with corresponding declines in production. As this is a type of good that is very trad-intensive global trade has been strongly affected accordingly.

However, the prospects for the world economy have stabilized. The one-year decline in business sentiment in the manufacturing sector has been stopped for the moment. Worldwide consumer sentiment remains optimistic, even if initial signs are becoming noticeable of a deterioration of consumer sentiment in advanced economies. This is likely to be related to the employment expectations in the manufacturing sector, which have worsened significantly. In the forecasting period, global output is expected to expand at average rates. Specifically, the output in advanced economies is expected to increase at rates slightly below the average, while the output in emerging economies will continue to grow at above-average rates. The trade restrictions that have already gone into effect between the US and China are dampening trade activity and reducing the willingness to invest. Uncertainty concerning the introduction of further trade restrictions between the two countries and regarding a spill-over of the trade conflict to Europe are also contributing factors. Until the transition to e-mobility has advanced a good deal further, expansion in the production of automobiles is expected to be weak. For the current year, worldwide car registrations are expected to fall by over 4%, following a decrease of 1.0% in 2018. That said, continued strong income growth in the advanced economies is likely to positively impact consumer expenditures. Overall, the world’s gross domestic product is expected to grow by 2.6% this year, by 2.5% next year, and by 2.6% in 2021.

Real GDP in the World - ifo Economic Forecast Winter 2019

Risks Outweigh Opportunities

The risks to global economic development continue to outweigh the opportunities. Although the trade conflict that the US has pursued with China presents opportunities as well as risks, those opportunities are contingent on the two countries quickly finding a compromise. However, the risk of further escalation is at least as great, and the spreading of the conflict to other countries and regions cannot be ruled out. China’s financial stability is also threatened by substantial risks. The country’s current monetary policy stance could have the effect of further increasing the already high indebtedness of the non-financial sector. This would make a re-evaluation of risks more likely and could lead to sudden sell-offs of certain financial assets on a large scale. Also, in many advanced economies the indebtedness of non-financial corporations has increased significantly over the past ten years. The increase in debt was mostly due to bond issues. If the economy and thus the earning prospects of these companies weaken more than expected, it could lead to revaluations of these and other asset classes. Furthermore, the timing and the terms of the exit of the United Kingdom from the European Union remain uncertain. Additional smaller-scale concerns include the political uncertainty surrounding possible conflicts within the ruling coalition in Italy, the ongoing lack of clarity regarding the formation of a new government in Spain, and the uncertainty with respect to the survival of the grand coalition government in Germany.

Contact
Prof. Dr. Timo Wollmershäuser

Prof. Dr. Timo Wollmershäuser

Deputy Director of the ifo Center for Macroeconomics and Surveys and Head of Forecasts
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+49(0)89/9224-1406
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+49(0)89/907795-1406
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