Joint Economic Forecast Autumn 2023: Purchasing power returns ‒ political uncertainty high

Germany has been in a downturn for more than a year. The sharp rise in energy prices in 2022 put an abrupt end to the recovery from the pandemic. High consumer price inflation is draining purchasing power from private households. Key interest rates have risen by over 4 percentage points, hitting the construction industry in particular. In addition, the policies of the German government are causing massive uncertainty among companies and households; this is making economic planning more difficult and hindering the economy’s quick exit out of the downturn.

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Development in Germany

All in all, gross domestic product will fall by 0.6% in 2023. The institutes are thus revising their forecast from spring 2023 sharply downward by 0.9 percentage points. The main reason for this is that industry and consumption are recovering more slowly than was forecast in the spring. For 2024, the forecast of 1.3% is only 0.2 percentage points lower than in the spring. In the following years, a decreasing growth rate of potential output due to the shrinking labor force will become more and more apparent. Economic policy should improve the quality of Germany as a business location and reduce political uncertainty, in particular in the context of the energy transition.

Business sentiment has recently deteriorated again, not least because of heightened political uncertainty. Overall, the indicators suggest that production fell noticeably once more in the third quarter of 2023. However, in the meantime, wages have picked up due to inflation, energy prices have fallen, and exporters have partially passed on their higher costs, so purchasing power is returning. As a result, the downturn is expected to subside at the end of the year and the degree of capacity utilization in the economy will rise again going forward.

The economic weakness has now also reached the labor market. However, the institutes expect only a moderate rise in unemployment to 2.6 million people in 2023. In the coming year, the number of unemployed will probably fall slightly.

On the price front, the situation is gradually easing. The inflation rate is expected to be 6.1% in 2023 and to decline to 2.6% in 2024. The institutes see core inflation (inflation excluding energy prices) at 6.1% in the current year and 3.1% in 2024.

The public budget deficit is falling to 2.2% in relation to nominal GDP in 2023 and is projected to decline further to 1.6% in 2024 and 1.1% in 2025. Although the debt brake was already reinstated at the federal level this year, the deficit is not falling faster. This is because the high margins for new borrowing under special funds in the national accounts have an impact on the deficit only when the funds are spent gradually.

Chart Joint Economic Forecast Autumn 2023: Gross Domestic Product in Germany

Political Uncertainty

Political handling of the energy transition is causing a great deal of uncertainty. If the government continues its policy of achieving emission reduction targets through small-scale interventions in the decisions of companies and households, instead of relying on efficient market-based instruments such as a sufficiently high CO2 price and certificate trading, the energy transition will ultimately become more expensive. A growing proportion of the investments made by companies and private households is being channeled into climate protection. It is true that this reduces greenhouse gas emissions and brings Germany closer to its emissions targets. However, the investments required for this are often early replacement investments that do not expand the capital stock. Simulations show that it is therefore highly likely that potential output will be dampened by the end of the decade. The extent of the losses depends, among other things, on the speed at which renewable energies are expanded and how flexibly companies can adjust their energy use in production.

Restructuring of the capital stock can proceed more easily if the willingness to invest is high anyway. To achieve this, it is necessary to improve conditions in Germany as a whole and not just for individual companies or economic sectors. For example, some indicators of a country’s attractiveness as a business location point to opportunities for improvement in the areas of taxes, climate policy, and the labor market. The planned Growth Opportunities Act is intended to improve investment conditions. Its measures are fundamentally suitable for promoting investment and thus increasing economic growth. However, with a planned total volume of just under EUR 7 billion per year, its scope is limited. In addition, the tax cuts envisaged in the government’s draft bill will worsen the financial situation of local authorities. There is therefore a risk that they will postpone investments.

Economic policy is not the only source of uncertainty, however. At present, something that until recently was taken for granted in Germany is coming under threat: namely, a social climate that gives households and companies the confidence that the basic rules of our society are generally accepted, and that these basic rules will therefore also endure in the future. These include such self-evident things as respect for all fellow human beings, for the property of others, and for people’s freedom of action. For some time now, extremist ideas have been gaining ground that call these self-evident principles into question. While the immediate economic risks of this trend may be limited, it poses considerable risks to the long-term prospects for growth and prosperity.