ifo Economic Forecast Autumn 2021: Supply Bottlenecks in Manufacturing Slow Overall Economic Recovery

For the further course of the forecast, it is assumed that infection rates will remain under control to such an extent that neither renewed government restrictions are necessary nor voluntary consumer restraint is to be expected. Any remaining restrictions will be gradually lifted by the end of the year, so that nothing should stand in the way of a full economic recovery in retail trade and in contact-intensive service industries. Accordingly, private consumption alone will continue to be the mainstay of economic recovery for the time being due to the normalization of spending behavior. This forecast does not take into account any additional catch-up effects. It is true that private households have accumulated considerable excess savings as a result of limited consumption opportunities since March 2020 and restrained spending on the part of cautious consumers. However, this forecast assumes that consumers will not spend these savings. The reasoning behind this is that a large part of foregone consumption relates to services that are difficult to make up. These include visits to hairdressers and restaurants, but also leisure, entertainment, and cultural events. In contrast, additional catch-up effects in the area of goods consumption is likely to be more limited. Purchases of goods, for example, have not collapsed on average in the six quarters since the start of the coronavirus crisis and were roughly the same as in the year and a half before. This has also been helped by spending on consumer durables, such as furnishings and household appliances, which on the one hand increased significantly in the second half of 2020 due to the reduction in VAT and on the other hand made up for a lack of alternative consumption options.

In manufacturing, the decline in value added is likely to continue in the third quarter and stop only toward the end of the year. Companies continue to assess their order and business situation as above average. However, the bottlenecks in the supply of raw materials and intermediate products have recently worsened. In the latest ifo Business Survey, conducted in August, the share of companies whose production is being hampered for this reason rose once again to almost 70 percent. The truck toll mileage index, which is a good indicator of the current trend in sales and production in manufacturing, has also weakened of late. Admittedly, it is not yet possible to judge whether the peak in bottlenecks has already been reached. Nonetheless, this forecast assumes that they will become less significant by the end of the year. This is based on the assumption that the shifts in the structure of demand observed worldwide in the wake of the coronavirus crisis will gradually reverse, thus eliminating one of the causes of the supply bottlenecks. A strong recovery in manufacturing can then be expected in the coming year, as existing orders will have to be processed – provided there is no increase in cancellations. However, the continued robust economic situation in the key sales markets for the German export industry will also contribute to this.

All in all, gross domestic product will increase by 2.5 percent this year and by 5.1 percent next year. The high growth rate in 2022 is largely due to the low level of production of goods and services in 2021. In the course of 2022, the momentum of the overall economic recovery will decrease. Compared to the ifo Economic Forecast Summer 2021, the growth rate for 2021 was thus lowered by 0.8 percentage points and raised by 0.8 percentage points for 2022. The shift in economic momentum from this year to the next is largely due to production difficulties in manufacturing. In 2023, the German economy will then expand again at normal rates.

Labor Market Recovery Continues

The labor market, too, is continuing to recover after the coronavirus crisis abruptly interrupted the long-standing upswing last year. As a result of the progressive openings in many sectors of the economy, unemployment and short-time work are likely to continue to decline rapidly over the forecast period. While short-time work will fall back to its pre-crisis level in the coming year, unemployment is likely to be even higher, with an annual average of 2.35 million people. It will not reach its 2019 level until 2023, when 2.27 million people will be unemployed. Behind this slower adjustment lies the assumption that the coronavirus crisis will also have structural consequences, with rising corporate insolvencies releasing workers who will only gradually find new employment in other sectors of the economy. However, in the coming years, demographic change and the associated worsening of the labor shortage, which is already becoming apparent according to the ifo Business Survey, are likely to contribute to a further decline in unemployment.

Key Forecast Figures for Germany

Source: Federal Statistical Office; Federal Employment Agency; Deutsche Bundesbank; 2021 to 2023: forecast by the ifo Institute.
© ifo Institute Sep. 2021

High Price Dynamics Only a Temporary Phenomenon

The inflation rate is likely to rise further to around 4.5 percent by the end of the year. Only in the coming year will it then gradually fall again and approach the 2 percent mark. This is mainly due to the fact that the base effects will peter out at the beginning of 2022, as it will be a year since the reduction in VAT was reversed and energy prices are expected to remain largely unchanged in the forecast period. The high price dynamics seen in some services in recent months is likely to have been only a temporary phenomenon and should weaken again as consumption patterns continue to normalize. A pass-through of rising prices for raw materials and intermediate products from producer prices to consumer prices was not assumed, as the material shortages underlying the cost increases will ease in the coming months. One factor dampening prices for the next two years is subdued wage settlements, which, in line with unchanged low medium-term inflation expectations, make a wage-price spiral appear unlikely. As a result, the inflation rate should average 3.0 percent in 2021, following an average of only 0.5 percent in the crisis year 2020. In the next two years, the upward trend in prices will then slow from an annual average of 2.3 percent to 1.6 percent.

2023 Balanced Government Budget

The current fiscal environment is characterized by extensive government measures to contain the health and economic consequences of the coronavirus pandemic. As a result, the government budget will once again close the current year with a significant deficit of just under EUR 160 billion. Next year the deficit will then be reduced to a good EUR 50 billion, mainly as a result of the strong recovery. In 2023 the government budget should be balanced again for the first time. This forecast of government revenue and spending was made on the assumption that only the economic and fiscal policy measures currently adopted will be implemented. Of course, much of this may change in the next legislative period, so that the forecast of government finances is currently subject to an above-average degree of uncertainty.

Risks: Infection and Vaccination Rates and Supply Bottlenecks for Intermediate Products

This forecast is subject to a number of risks. One significant downside risk for the coming months stems from the assumed rates of infections and vaccinations. If, contrary to the assumption made here, there is another lockdown in the fall, the projected recovery in trade and contact-intensive services in the second half of 2021 is likely to be too optimistic and will be delayed into 2022. However, private consumption could also recover faster than outlined in this forecast if the excess savings accumulated during the coronavirus crisis are spent and thus impact demand.

Downside risks also exist in connection with the assumed effects of bottlenecks in the supply of intermediate products. In this forecast, it was assumed that the bottlenecks would gradually ease by the end of the year. However, if they were to worsen and last longer, the associated production losses would be greater and there would be a risk that the recovery of the German economy would slow down further.

Finally, there is also uncertainty with regard to the direction of fiscal policy after the German federal elections. The parties are discussing various reforms of the tax and contribution system as well as climate policy measures that could result in both additional burdens and relief for private households and companies compared with the status quo assumed in this forecast. It could also be questioned whether the consolidation course assumed in this forecast will actually be adopted in the coming year.