Contrary to long prophecies, the German economy will not fall into recession this year. At least that’s what the leading economic institutes expect. Despite energy shocks, inflation and bank tremors, they even predicted slight economic growth of 0.3 percent on Wednesday. Important for all citizens: The wave of inflation will therefore recede until next year. This would allow Germany to come out of the numerous threats with a black eye. However, there are a few dangers that could make things worse.
Why the big drama didn’t happen
“The serious downward risks have not occurred,” says Achim Truger Süddeutsche Zeitung. The economist from the University of Duisburg-Essen recently presented a similar forecast with the Federal Government’s Advisory Council. “It’s positive that there was no gas shortage that would have shut down parts of production,” he says. People are consuming more than they think. However, the economic recovery is initially weak. Inflation reduces income and thus slows consumption – and the rise in key interest rates is causing the construction industry to collapse.
Last autumn, the four leading economic institutes Ifo, Ifw, IWH and RWI assumed that the economy would shrink by 0.4 percent this year. That was before the winter with a possible gas shortage – and before the federal government’s gas and electricity price brake. “The energy price brakes have pushed down inflation, strengthened consumers’ purchasing power – and thus supported the economy,” says Ifo economic chief Timo Wollmershäuser.
Now there is new impetus: According to the institute’s spring report, net wages will rise by seven percent this year, primarily as a result of the numerous wage agreements. From the second half of the year, incomes will rise faster than prices, which is why people should consume more. Industry is benefiting from falling energy prices, especially energy-intensive sectors such as chemicals, which reduced their production by a full 20 percent in 2022. And there are other positive factors for all companies: less sick leave, fewer delivery bottlenecks, more growth in China. The big question is: will the turbulence on the financial markets throw everything off?
How the financial turmoil works
Since the bankruptcy of several small US banks and the emergency takeover of Credit Suisse by rival UBS, some have feared a new financial crisis. The German Economic Institute (IW) has just simulated that a new banking crisis would plunge Germany into a recession. The IW assumes a ten percent loss on the stock exchanges in 2023 and less investment due to fewer bank loans. That would cost the German economy a total of 2.5 percent growth this year and next.
However, the institute emphasizes that it is only going through this development theoretically, but does not assume it. In their report, the economic institutes also do not assume that the bank quake will dampen the economy. “We don’t expect a credit crunch,” says Wollmershäuser from the Ifo. In a recent survey by the institute, German banks reported that they were more willing to lend than at the end of 2022. “The European banking system is prepared for government bond price losses.”
The economist Achim Truger points to the problems caused by rising interest rates in commercial real estate, for example: “The risk of a credit crunch has increased. And if such a crunch occurs, a recession would be inevitable.” But the German Council of Economic Experts also considers a credit crunch to be so unlikely that it does not assume any damage to the economy from the bank earthquake in its forecast. “The current crisis is not at all comparable to the financial crisis of 2007/2008,” says Truger. “Back then, nobody knew who still had valuable paper on their balance sheet. The trust was gone.” This time it is about possible liquidity problems of the banks, which is more manageable. “And politicians are already reacting.”
When will there finally be growth?
If the bank quake doesn’t wreck the economy, the German economy could grow reasonably well again next year. The Advisory Council expects a plus of 1.3 percent, and the economic institutes expect a plus of 1.5 percent. The industry has a large backlog of orders and should continue to recover. In construction, the institutes are expecting an end to the downturn. There is no question that the higher interest rates will hurt even then. But there are factors that support the construction. For example, the still enormous need for additional apartments – or the energetic renovation for climate reasons.
1.5 percent more growth in 2024 would be better than the near stagnation this year. However, as an upswing after the difficult years of the corona and energy crisis, that sounds pretty poor. That could be a foretaste that the German economy will grow more slowly in the future. In the second half of the decade, economic researchers expect average growth of just over half a percent per year. Timo Wollmershäuser warns that aging and a shortage of skilled workers are putting pressure on the economy. And if the economy is now converted to be climate-friendly, the capital stock will not be expanded, which would generate growth, but only replaced, for example in electricity production: coal, gas and nuclear power out, renewable energies in. The hope is that the German economy will gain a technological lead through the restructuring and conquer new lead markets worldwide. According to Wollmershäuser, no one knows whether that will happen.
Consumption is likely to be the biggest driver of the economy next year because wages are rising sharply. And because inflation is forecast to calm down. How exactly will the prices develop?
And the inflation?
The economic institutes expect inflation to remain high this year: at six percent, slightly lower than in 2022. Energy prices are falling. Triggered by the Russian invasion of Ukraine, they, together with food prices, triggered high inflation. But meanwhile, inflation is taking hold in other areas of the economy. The so-called core rate of inflation, which calculates the often fluctuating energy and food prices, is forecast to be even higher than normal inflation.
Timo Wollmershäuser also blames the electricity and gas price brakes and the other relief provided by the government. On the one hand, they support the economy. By driving up demand, they drove up prices. Because the demand meets an offer from the economy, which is limited by supply chain problems, material bottlenecks and a shortage of skilled workers, at least for a while. The core rate of prices will remain higher than normal inflation (2.4 percent) at 3.3 percent in 2024. But of course the trend would be a welcome normalization for citizens if the forecast comes true.
Wollmershäuser does not expect any strong pressure on prices from wages. “Only if wage increases of ten percent year-on-year were agreed, then that would be a new cost factor that would drive up inflation. It doesn’t look like it.” Wollmershäuser sees two conditions for inflation to really normalize: Further interest rate hikes by the European Central Bank of up to one percent to counteract inflation. And no more big government fiscal programs.
Achim Truger from the German Council of Economic Experts warns that excessive government restraint could also have negative consequences. “If the federal government were to switch to an austerity course, there could be a drop in demand, which would put pressure on the economy. Fiscal policy must not consolidate too quickly. Municipalities are already postponing certain investment projects.”
Truger criticized that the federal government had unnecessarily robbed itself of its financial leeway. “If she hadn’t compensated for the cold tax progression so early and generously, she would have had ten billion euros more at her disposal. And if she had drawn the exceptional rule of the debt brake again for 2023, as the Council of Economic Experts thought it made sense, she would have 40 billion euros more available. Instead, it has created a fiscal cliff to fall off.”