1. After a close election in September, a “grand coalition” government took office on November 22, 2005. The government comprises the Christian parties (Christian Democratic Union and Christian Social Union) and the Social Democratic Party, and is headed by Mrs. Merkel (CDU). Mr. Müntefering (SPD) is Vice-Chancellor and Minister of Labor and Social Security.
2. As envisaged in the staff report for the 2005 Article IV consultation with Germany (September 20, 2005), a second round of discussions was held with the new authorities and staff at the Bundesbank.1 This supplement reports on these discussions, which centered around the coalition agreement issued by government partners on November 12, 2005.2 An updated staff appraisal based on these discussions is included in this supplement.
The discussions took place on December 12-14, 2005 in Berlin and Frankfurt. Meetings were held with Finance Minister Steinbrück, State Secretary of Finance Mirow, State Secretary of Labor and Social Security Anzinger, senior representatives at the Chancellery, the Ministries of Finance, Economy, and Labor and Social Security, parliamentarians from both major parties, and staff at the Bundesbank. The staff team comprised Mr. Chopra and Mr. Traa. Mr. Bischofberger, Germany’s Executive Director, attended the discussions.
In addition, on October 18, 2005, the authorities provided an updated Notification of Restrictions Under Executive Board Decision No. 144-(52/51) concerning certain payments restrictions.
A technical error in the design of the UB-II program had caused a sharp increase in the marginal tax rate for participants who were transitioning from welfare to work. This distortion had significantly weakened the effectiveness of the program and raised costs as participants did not make the transition. See also ¶28 of the staff report.
See also Berger and Danninger (2005), “Labor and Product Market Deregulation: Partial, Sequential, or Simultaneous Reform?” IMF Working Paper, WP/05/227, which was prepared as background for the Article IV consultation discussions with Germany.
The VAT increase is expected to be reflected only partially in headline inflation because categories subject to the reduced 7 percent rate are exempted, and with the wage wedge declining slightly, suppliers do not need to adjust output prices fully with the tax hike.