Upturn continues
Ifo Economic Forecast 2014/2015
World Outlook | Risks | German Economy | German Outlook
World economic situation
Thanks to developments in the advanced economies, growth in the world economy has picked up slightly since summer 2013. The economic recovery in the USA, Great Britain and Japan gained momentum, while the euro area emerged from a recession that lasted almost two years. Although the emerging economies continued to post higher growth rates than advanced countries, the economic expansion in the former remained relatively weak by historical standards, and has slowed down even further since summer 2013 in some areas.
Monetary policy in the major advanced economies remains very expansive. Central banks in Japan and the euro area are expected to continue to pursue a highly accommodative policy, whereas initial increases in base rates are expected in the USA and Britain during the forecasting period in view of the strengthening economic recovery. Monetary policy has become more restrictive in key emerging economies since summer 2013. Central banks reacted to the strong depreciation of their currencies - triggered, among other factors, by the monetary policy turnaround in the USA - with interest rate increases.
The restrictiveness of fiscal policy will differ significantly across the major advanced economies both this year and in 2015. In the euro area fiscal policy interventions will have very little impact on aggregate economic output. In the USA and Japan fiscal policy is expected to remain restrictive. In the majority of the emerging economies the effect of fiscal policy is mostly expected to be neutral. India and China are the only nations in which public investment programmes are expected to reinforce economic activity this year.
The pace of global economic expansion will pick up moderately over the forecast horizon, primarily driven by the advanced economies. The US economy will gain impetus, boosted by an improvement in the asset position of households and companies, further brightening in the labour and real-estate markets, and expansive monetary policy. Economic developments in the euro area will remain plagued by complex structural problems that are still present in several member states and will take some time to solve. The recovery in aggregate economic activity will temporarily stabilise, despite the continued existence of major differences between member states. Growth in the German economy, in particular, will far outstrip the euro area average for the forecasting period, while economic momentum in France and Italy will be relatively weak. The situation in the crisis-afflicted countries of Ireland, Portugal and Spain is expected to be somewhat more positive, although the economic situation remains fragile. Greece is still waiting for an economic recovery, but several years of recession may come to an end in 2015.
The pace of expansion in emerging economies will barely pick up in the forecasting period. Although they will benefit from the economic upturn in key advanced economies, the gradual rise in long term interest rates in the US will, at the same time, result in a steady deterioration of financing conditions for emerging economies. Nevertheless, aggregate economic production in emerging economies will grow at over twice the rate as in their advanced counterparts. Russia is the only country that is expected to experience an economic downturn this year. All in all, aggregate world economic production will rise by 2.9% this year and 3.3% next year.
One of the main risks for the world economy remains the fragile situation in the Eurozone. Despite the reform measures recently introduced by several member states, the adjustment process is far from complete. As a consequence, many of these countries remain far too expensive to be competitive. As in the past three years, crises could erupt at any time.
Falling inflation rates in the Eurozone, which can now be seen in all member states, entail risks and opportunities. The fall in inflation is admittedly largely due to the appreciation of the euro and developments in the price of energy commodities and food. Moreover, disinflation, or even deflation, is thoroughly desirable for crisis-afflicted countries in the mid-term, since it would facilitate an urgently needed real depreciation vis-à-vis key trading partners and the long-awaited improvement to their international competitiveness. At some point, however, a long phase of low inflation, affecting the healthy part of the monetary union as well as the prices of goods and services, could lead to a downward revision of long-term inflation expectations by investors, consumers and producers. In extreme cases, a spiral of inflation decreases and successive drops in inflation expectations could arise, resulting in a lasting phase of deflation. However, according to the Ifo Institute’s estimates, the positive effects of a correction of relative goods prices continue to prevail for the moment.
Lastly, there are geopolitical risks related to the ongoing Russia-Ukraine conflict and recent civil-war like tensions in Iraq. An escalation of the conflict with Ukraine could lead to a spiral of sanctions by both sides between Russia and the West. Civil war in Iraq could destabilise large parts of the Middle East. Since this region is among the world's key oil producers, disruptions there could lead to an oil price spike and may trigger a slowdown in global economic momentum.
Aggregate economic production in Germany rose sharply by 0.8% in the first quarter of 2014, entirely fuelled by domestic demand. Equipment investment rose by 3.3% versus the previous quarter thanks to higher capacity utilisation and more favourable earnings outlook and financing conditions; completing the economic turnaround. The upturn in construction investment was even brisker at 3.6%, boosted by the exceptionally mild winter. Private consumption expanded by 0.7% in real terms, fuelled by the rise in employment and a slight decline in the savings rate. Foreign trade itself contributed negatively to the change in real GDP after the turn of the year. While exports increased by 0.2%, there was a 2.2% upturn in imports against a background of lively domestic demand. However, it is important to bear in mind that this effect only reflects a slight drop in net capital exports and higher investment in Germany, which in themselves have favourable supply and demand effects on German economic growth.
Although the most important economic indicators have remained at a high level of recent months, they did not continue to rise any further as at the beginning of the year. The most recent decreases in the Ifo Business Climate Index were primarily due to growing uncertainty among German manufacturers over the Russia-Ukraine conflict. Since the spring upturn was also particularly weak this year due to the mild winter, the 0.3% growth in aggregate economic production that will be seen for the second quarter is far less dynamic than in the previous quarter.
Outlook for the German economy
The general economic trend in the forecasting period will remain clearly upwards during the forecasting period and the upturn will continue. If, as assumed by this forecast, current geopolitical risks do not materialise, the business conditions for the German economy will remain favourable. Monetary policy is expected to remain expansive, interest rates will stay at their historic lows and the construction boom will continue uninterrupted. Financing conditions for companies will remain extremely favourable. Fiscal and social policy is expected to provide expansive, pro-cyclical stimuli. Investment in new equipment will rise at a faster pace, high production capacity utilisation rates will necessitate investment in replacements and expansion. In addition, construction investment will continue to rise. Private consumption is expected to increase at the same pace as real income. Thus, like last year, demand-side momentum should come from the domestic economy and not from net exports. Although growth in exports will rise, thanks to an improvement in the world economy, it will be outstripped by growth in imports due to strong domestic economic dynamics. Overall real GDP will increase by 2.0% this year and 2.2% in 2015.
The labour market situation will cyclically continue to improve over the course of this year. The drop in unemployment is forecast to be lower than the increase in employment, since a growing number of German residents are in active employment and migration from EU member states is expected to remain high. The unemployment rate will fall to 6.7% this year. In 2015 the situation in the German labour market will be affected by the introduction of a nationwide minimum wage of 8.50 euros/hour. This will lead to a notable increase in labour costs and will thus lead to job losses, especially in the field of so-called mini-jobs that are not subject to social insurance contributions. Due to the favourable general economic trend, however, the situation in the labour market remains stable, despite the dampening effects of the minimum wage, and the unemployment rate is expected to drop again to 6.6%. The negative impact of the minimum wage will accumulate over several years, just as the full positive impact of the reduction in wage claims resulting from the Schröder reforms did not emerge until several years after their implementation.
Consumer prices are expected to increase by 1.1% this year. The inflation rate will rise to 1.7% in 2015. This primarily reflects developments in labour costs, which are expected to increase significantly due to rising production capacity utilisation and the introduction of a legal minimum wage.
The budget surplus of the German government will continue to grow over the forecast horizon, partly because significant additional revenues from taxes and social contributions can be expected due to the improving economic situation and favourable developments in wages and salaries. A budget surplus of 0.5% in relation to GDP is expected in 2014, and of around 0.7% in 2015. General government gross debt looks set to fall considerably to around 70% by the end of 2015.
For a detailed presentation of the economic forecast (in German) see T. Wollmershäuser, W. Nierhaus, T. O. Berg, C. Breuer, C. Grimme, S. Henzel, A. Hristov, N. Hristov, M. Kleemann, W. Meister, J. Plenk, C. Seiler, L. Wieland, K. Wohlrabe, A. Wolf: ifo Konjunkturprognose 2014: Deutscher Aufschwung setzt sich fort, ifo Schnelldienst, forthcoming.
The forecast can be accessed and downloaded here or requested via email to presseabteilung@ifo.de.