ifo Economic Forecast Spring 2021: German Economy Staggering into Third Coronavirus Wave

Broad Recovery Yet to Set In

The recovery in manufacturing continued at the beginning of 2021. New orders, export expectations, and the business climate all rose strongly until recently, so value added in manufacturing and related services as well as exports are expected to provide tangible support for the economy in the first quarter. In the other service sector, value added continues to be driven by infection levels. In particular, the closure of the stationary non-food retail sector is likely to have a major impact on economic momentum in the first quarter. In the other consumer-related services, however, the negative impetus is diminishing compared with the final quarter of 2020, as sales and the business situation have tended to move sideways at a low level since November. All in all, price-adjusted GDP is expected to fall by 0.7 percent quarter over quarter in the first quarter of 2021.

How the economy develops further depends crucially on the Covid-19 caseload. A start was made in March on easing individual infection control measures. This in itself suggests that the sectors affected will be able to ramp up their activity again. Experience from last summer shows that the associated economic recovery can be very rapid. However, the current easing is taking place at a time when the spread of infections is not under control and the vaccination campaign is in danger of faltering. There are therefore many indications that the latest easing measures will soon be withdrawn again and that a thorough recovery will be a long time coming. However, demand for services involving close social contacts is unlikely to develop fully even if previously relaxed measures are not tightened again as the incidence rate continues to rise. Against this background, overall economic activity should expand at a similar rate of around 2 percent in both the second and third quarters of 2021. The pre-crisis level of output of goods and services is still expected to be reached at the end of 2021.

Overall, price-adjusted GDP is expected to increase by 3.7 percent this year. In the coming year, quarterly growth rates will gradually normalize. On average for 2022, price-adjusted GDP will nevertheless be 3.2 percent higher than this year due to the strong recovery at the end of the current year. Looking at total economic output for the years 2020 to 2022, the cost of the coronavirus crisis according to this forecast is EUR 405 billion.

Falling Unemployment from the Middle of the Year

The coronavirus crisis has also left deep scars on the labor market. A large part of the economic slump was absorbed by a reduction in employees’ working hours and thus by the use of short-time work, which currently affects mainly employees in the retail and hospitality sectors. Job losses were rather small compared with the reduction in working hours. In the wake of the first wave of coronavirus, the number of unemployed rose by just under 670,000 to 2.94 million people in June 2020. Since then, unemployment has declined steadily, rising slightly for the first time by 9,000 to 2.75 million people in February 2021. The ifo Employment Barometer points to a further slight increase in unemployment in the coming months. It is true that the willingness to hire has increased in the manufacturing sector. However, retailers and a number of service providers in particular are showing restraint. Nevertheless, unemployment is expected to fall again from mid-year at the latest as the economy recovers. By the end of the forecast period, it will gradually fall to 2.4 million people and thus not return to its pre-crisis level.

Key Forecast Figures for Germany

Source: Federal Statistical Office; Federal Employment Agency; Deutsche Bundesbank; 2020 to 2022: forecast by the ifo Institute.
© ifo Institute March 2021

Rising Inflation Rate

The inflation rate rose sharply to 1.3 percent at the beginning of the year, after being negative almost throughout the second half of 2020. This was partly due to the renewed increase in value-added tax, the reduction of which had previously also been a key factor in the negative inflation rates. Moreover, energy prices have been rising significantly since the end of last year, mainly due to rising crude oil prices but also to the introduction of a carbon price for fossil fuels on January 1, 2021. Beyond these special effects, which have a one-off impact on the price level, purely cyclical inflation momentum, measured in terms of consumer prices adjusted for energy prices, is rather weak and even lower than in the first half of 2020. By the end of the current year, inflation will accelerate strongly once again and reach rates of over 3 percent. Purely cyclically driven inflation, measured by average prior-month rates of change in the consumer price index excluding energy, is expected to remain low, hovering around 1.4 percent.

Risks: Infection and Vaccination Rates and Faster Recovery of Demand

The macroeconomic outlook is subject to many uncertainties. A significant downside risk for the coming months arises from the assumed rates of infections and vaccinations. If, contrary to the assumption made here, the recovery does not start now, for example because there is another full shutdown, the forecast for this year is probably too optimistic. Assuming, for example, that sales in the services that depend on intensive social contacts remain at the low level recorded at the beginning of the year for a further three months and that a gradual opening takes place only from June, the increase in GDP in the second quarter of 2021 is reduced from 2.1 percent to 0.9 percent. The recovery is thus likely to shift further into the third quarter and then boost the overall increase in output from 1.8 percent to 3.2 percent. It is assumed that the manufacturing- and construction-related sectors of the economy develop in the same way in both scenarios. Overall, in the risk scenario, the growth rate for 2021 would be 0.3 percentage points lower at 3.4 percent. In the coming year, it would be 0.2 percentage points higher, also at 3.4 percent. The additional loss of value added associated with the delayed recovery would total EUR 13 billion.

Ultimately, however, overall economic demand could recover more quickly than outlined here. As a result of the limited scope for consumption and of restrained spending on the part of cautious consumers, private households accumulated surplus savings of over EUR 100 billion last year; savings are likely to increase again in the current quarter. This forecast assumes that households will not spend these savings during the recovery phase and that the savings ratio, which had risen temporarily to around 20 percent during the two shutdown phases, will return to its pre-crisis level of 11 percent by the end of 2021. Nonetheless, there is a chance that at least some of the excess savings will be spent, driving demand. The savings rate would then temporarily fall below 11 percent.