2010 Article IV Consultation-Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Germany

This 2010 Article IV Consultation highlights that the German economy is regaining the ground lost in the crisis. Policy support, restocking, and an uptick in global demand have lifted the economy from the recession. The authorities used the available fiscal space to implement countercyclical policy measures. Financial sector measures helped stabilize financial markets and mitigated systemic risk, but vulnerabilities remain. Executive Directors have welcomed the authorities’ fiscal strategy that combines short-term support for the economy with a firm commitment to fiscal consolidation in the medium term.


This 2010 Article IV Consultation highlights that the German economy is regaining the ground lost in the crisis. Policy support, restocking, and an uptick in global demand have lifted the economy from the recession. The authorities used the available fiscal space to implement countercyclical policy measures. Financial sector measures helped stabilize financial markets and mitigated systemic risk, but vulnerabilities remain. Executive Directors have welcomed the authorities’ fiscal strategy that combines short-term support for the economy with a firm commitment to fiscal consolidation in the medium term.

I. The Context1

1. Strong policy support helped Germany emerge from the deep recession. Germany was hit exceptionally hard by the crisis. But financial sector measures mitigated systemic stress and supported credit (Box 1). Automatic stabilizers and significant fiscal stimulus contained the downswing and supported the recovery. And the surprisingly strong German labor market reflected flexibility gains from past labor market reforms, together with the expansion of the short-term subsidies (Kurzarbeit) program.

2. With a moderate, but fragile, recovery underway, policy demands are changing. While crisis policies need to continue in some areas, there is a need for exit in others.

  • Fiscal policy: The recovery continues to rely on fiscal support for one more year, but consolidation is in order once private demand has become self sustaining. This sits uncomfortably with plans for tax cuts in 2011.

  • Dealing with the crisis aftershocks: With liquidity conditions set to tighten and credit playing a crucial role for the recovery, time is running out for solving the remaining banking sector problems, in particular in the Landesbanken sector.

  • Financial stability framework: Ensuring and improving financial stability remains important, and the authorities are proceeding—if gradually. A plan to introduce a banking resolution regime is being discussed, and there is a commitment to increase the Bundesbank’s role in prudential supervision. However, little progress is being made in addressing the still fragmented deposit insurance system. An FSAP Update is planned for late 2010.

  • Allowing adjustment: Short-term crisis policies in the labor market and state aid to smooth employment could become impediments to long-run growth if continued indefinitely. The adjustment to slower foreign demand would benefit from service sector and labor market reforms to strengthen domestic sources of growth.

3. Successfully tackling the crisis fallout will also help sustain the upswing in Europe and elsewhere, with positive feedback effects for the German economy. Europe’s tightly integrated trade and financial markets create substantial spillovers, but they also open the door to positive feedback effects from fiscal consolidation and solving the remaining banking sector problems. These effects are particularly strong for a large and open economy such as Germany. Strengthening domestic sources of growth would contribute to the reduction of both euro area and global current account imbalances and, thereby, reduce the risk of rapid or excessive exchange rate movements which tend to hurt trade.

II. The Outlook

4. The global forces that drove Germany’s economy into the crisis have pulled growth back into positive territory. The uptick started in the second quarter of 2009, led by exports and aided by policy support and restocking of inventories. Reflecting restocking and the high import content of German exports, import growth has picked up, too, reducing the contribution of net exports to growth. Private consumption, which held up well during the recession against a background of surprisingly stable employment, oscillated first upward and then downward in reaction to fiscal incentives, especially the car scrapping program.


Growth has picked up.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: IMF, WEO.

Sentiment has improved, helped by export demand.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: Haver.

5. Staff and authorities see the recovery as moderate. A number of factors are at play. With U.S. consumers likely to show restraint for some time and global policy support eventually fading, the scope for export growth beyond the current global inventory bounce is limited. Continuing banking problems will put pressure on credit supply and possibly domestic demand as the recovery matures. Unemployment is projected to increase as firms adjust to the reality of lower post-crisis growth and government subsidies for short-time work lose their lure, which will further limit consumption. And it will take time to repair the damage to potential growth done by the crisis. Following an estimated drop of about 5 percent in 2009, staff now projects GDP to grow by 1.2 percent in 2010 and 1.7 in 2011. While the government’s projections are a shade more optimistic than staff’s, there is broad agreement that the uncertainty around the recovery path comes with a downward bias, owing to risks to exports and the financial sector (such as a credit crunch, or spillovers from emerging and Southern European markets). Such setbacks could have self-enforcing effects, with additional pressures on unemployment.

Main Policy Measures 2009

During 2009, the German authorities took action in a broad range of policy areas, including fiscal, financial, and the labor market.

In the fiscal area, the authorities combined significant short-term stimulus with a strengthening of the medium-term framework:

  • Reacting to the depth of the downturn, the authorities in February enacted a second stimulus package (Konjunkturpaket II) with a fiscal cost of about 2 percent of GDP distributed across 2009 and 2010. In addition, the authorities extended the cash-for-clunkers scheme, which had a notable impact on car sales and private consumption (Box 5). The year also saw reductions in contribution rates to unemployment and health insurance in January and July, respectively. In December, the new government followed up with the Wachstumsbeschleunigungsgesetz, with tax breaks and transfers of about ¼ percent of GDP.

  • At the same time, the new fiscal rule (“Schuldenbremse”), anchored in the constitution in June, now limits the structural deficit of the federal government to 0.35 percent of GDP starting in 2016—to be reached in roughly equal consolidation steps starting in 2011—and that of the Länder to balance by 2020, setting clear limits to debt accumulation in the medium term.

In the labor market, key actions during the first half of 2009 included measures that enhanced the generosity of the very effective short-time (Kurzarbeit) subsidy scheme, including increased subsidy levels and longer durations of eligibility (Box 2).

A series of financial sector measures helped stabilizing the banking sector:

  • The Sonderfonds Finanzmarktstabilisierung (SoFFin) established in 2008 (see Box 7) helped stabilizing the banking sector, including through recapitalizations of Commerzbank and Hypo Real Estate (HRE) (see separate text figure).

  • The Finanzmarktstabilisierungsergänzungsgesetz in April introduced a temporary option for public takeover of banks, allowing the October nationalization of HRE.

  • The Gesetz zur Fortentwicklung der Finanzmarktstabilisierung (Bad-Bank-Act) passed in July allows banks to transfer impaired assets to specially created legal vehicles in return for SoFFin-guaranteed government bonds and a fee. The scheme includes additional options supporting bank consolidation, including through removing entire business areas from the core bank.


Exports and GDP will recover, but not to their pre-crisis trend…

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: Global Insight, staff projections.1/ Based on a linear trend estimate during 1995-2004, excluding the three pre-crisis years.

…contributing to a moderate recovery with significant fragilities.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: Global In sight; and Staff Projections.

A. Export Growth

6. Germany is tied closely to the ups and downs of the global economy. German recoveries traditionally start with a pick-up in exports, reflecting the importance of the foreign-demand-oriented manufacturing sector in value added. The draw of demand from EU neighbors—including from the euro area—is particularly important, given these countries’ large share in German trade. But non-EU export growth picked up considerably in the run-up to the crisis, as German manufacturers profited from strong U.S. and Asian demand.


German exports follow global markets

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: Haver and IMF, WEO.

7. Export growth is likely to be lower following the crisis. The recovery in Europe is projected to be slow, with particular weaknesses in the South. U.S. consumers are likely to show some restraint relative to their pre-crisis spending, which will moderate global demand, especially once the effects of global fiscal stimulus and restocking subside. And while Chinese growth is expected to remain high, its overall pull remains relatively limited due to the still small share in German exports.


China exports grow strongly, but from low levels.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: IMF, DOT.1/ Corrected for approximate trade through third countries.

8. Another moderating factor could be the dent the crisis put into German competiveness. While the euro has been depreciating more recently, it had gained in strength against the U.S. dollar and major currencies in the course of the global crisis. In addition, wage growth picked up markedly just prior to the crisis in early 2008, ending a period of wage discipline. These developments, together with an increase in unit labor costs caused by labor hoarding, have put upward pressure on the ULC-based real exchange rate.


Germany has recently lost competitiveness…

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: IMF, IFS.Note: Arise in the real exchange rate corresponds to an appreciation.

…due, in part, to a resurgent euro…

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: IMF, IFS.Note: Arise in the exchange rare corresponds to an appreciation of the Euro.

9. However, CGER estimates suggest that the deterioration in competitiveness has been small, with Germany retaining a small competitiveness advantage. According to the External Sustainability approach, the current account surplus substantially exceeds what is required to sustain net foreign asset levels, implying a strong competitive advantage. But the enduring tradition of German current account surpluses suggests that other factors not captured by the approach (including perhaps a preference for the accumulation of foreign assets) play a role, which could overstate competitiveness. The Equilibrium Real Exchange Rate concept—which compares the actual and a computed equilibrium real exchange rates—indicates a small competitive disadvantage, but could also be misleading because of it relies on CPI-based real exchange rates and ignores real wage developments. The Macrobalances approach may be best suited for Germany. It reflects the difference between the actual savings-investment balance and a computed equilibrium (based, among other things, on estimated saving preferences and demographic factors), and puts Germany at a broadly neutral level. Taking a simple average of these measures—as is customary—suggests that Germany retains a small competitive advantage, consistent with the authorities’ analysis. In addition, wage growth has started to moderate since mid-2008 and labor hoarding is expected to unwind, which will lift productivity.

Germany: Competitiveness Assessment1/

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Source: IMF staff estimates.

A negative number indicates a competitiveness advantage.


Real wages increased before and ULC during the crisis, but both have started to adjust.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: Bundesbank.

German current account moves closer to its medium-term equilibrium level.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: Authorities, staff projections and estimates.1/ The equilibrium CA beyond 2009 is based on a simulation taking into account the forecasted change in the overall CA.

10. As for the current account position, the outlook is for a moderation of the surpluses. Under the baseline scenario, the current account surplus will fall significantly from its pre-crisis heights, reflecting lower export growth. After reaching 7½ percent of GDP in 2007, it is projected to reach 5½ percent of GDP in 2010. This would bring the current account surplus broadly in line with the equilibrium level suggested by the Macrobalances approach. However, the current account surplus could be even lower if downward risks for export growth were to materialize: demand from Asia could fall short of expectations and a sharp depreciation of the U.S. dollar in tandem with Asian currencies could add additional downward momentum.


Despite a much larger drop in GDP

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: WEO and REO: Europe, October 2009.1/ Median log differences from one year earlier; quarters on x-axis; peak in output at t-0.

B. Labor Market

11. Employment held up extraordinarily well during the recession. The drop in GDP was among the highest among EU countries and much more pronounced than in past downswings. Yet, employment was astoundingly robust. Unemployment increased only moderately from 7.2 percent in the third quarter of 2008 to 7.5 percent in the fourth quarter of 2009, sparking speculation about the reasons behind the German “labor market miracle.” A closer look reveals a combination of factors at work (Box 2). Statistical changes played a role, but more important were increased firm-level flexibility to smooth working hours over the cycle (owing to less restrictive collective bargaining agreements), and a stronger underlying employment trend supported by the labor market reforms of recent years (Hartz IV). The single most important crisis policy influencing employment has been the government program subsidizing short-time work (Kurzarbeit). While Kurzarbeit has long been a staple of German labor market policies, the scheme was made significantly more generous during the crisis. At its peak, over 1.5 million employees (or 3.5 percent of the labor force) worked under the scheme, mostly in the hard-hit manufacturing sector.


…employment has held up better than during past recessions.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: WEO and REO: Europe, October 2009.1/ Median log differences from one year earlier; quarters on x-axis; peak in output at t-0.

Actual and Expected Unemployment 1/

(percentage points)

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: Global In sight; and staff estimates.1/ Based on an empirical model relating real GDP growth to changes in unemployment during 1991Q1:2008Q1.

12. But both authorities and staff see unemployment increasing as firms adjust to lower post-crisis growth. While the Kurzarbeit subsidies have helped firms to hold on to their workforce, they also increased hourly labor costs. As a consequence, firms will eventually need to adjust employment—in particular, if they have reason to expect that demand will not return to pre-crisis levels soon. Thus, even with the Kurzarbeit scheme in place, a moderate recovery will see unemployment increase. Staff expects unemployment to increase during 2010, reaching a peak of 9.5 percent by the end of the year. The authorities have a broadly similar view of the labor market outlook but see unemployment increasing more gradually. The increase will be fueled by layoffs, including by employees exiting from the Kurzarbeit scheme into unemployment.


Unemployment will increase as labor hoarding unwinds

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: IMF, WEO; and staff estimates.1/ Based on estimates of the relationship between changes in unemployment and GDP growth during 1991Q1:2008Q1.

13. The deterioration of the labor market will weigh on consumption and the recovery. The increase in unemployment, and the increased employment uncertainty created by it, will have a dampening effect on consumption, as households deal with income losses or spend more cautiously to prepare for the eventuality.2 This effect is exacerbated by low expected wage growth during 2010. While this moderates expected growth, the risks resulting from labor market developments to the forecast should be broadly balanced.

Why has Germany’s Employment Held Up So Well?

Despite the large decline in output, employment has fallen by less than ½ percent since its peak, a remarkably mild response both historically and internationally. Extrapolating from the past relationship of GDP growth and unemployment changes, unemployment would have reached about 9.5 percent—about 2 percentage points higher than observed. (The gap could have been three times as high if unemployment had reacted as strongly as in the United States).

The moderate unemployment response reflects in part an improved underlying employment trend supported by the labor market reforms (Hartz IV), and, importantly, increased firm-level flexibility to smooth work hours over the cycle owing to less restrictive collective bargaining agreements.1/ Indeed, much of the adjustment has taken place internally—and, thus, less visibly—through working hours reductions. Some of the hours reductions were due to work-sharing arrangements negotiated between firms and employees (often as part of bargaining agreements), especially the use of worktime accounts (Arbeitszeitkonten). They were also supported by short-time subsidies (Kurzarbeit), traditionally a feature of the German labor market, that were made substantially more generous in 2008/09.2/ Take-up reached over 1.5 million workers at its peak, a full-time equivalent of nearly half a million positions, surpassed only by the levels during the post-reunification years.


Labor market adjustment has been predominantly on the intensive margin…

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: Haver and OECD.1/ All series are normalized to 2008Q1 = 100.

Whether employment losses can be avoided also in the medium term depends on a number of factors. First, the flexibility offered by Arbeitszeitkonten has been largely exhausted, and given that firms face residual costs on short-time work, many may be forced to lay off workers if production levels remain low for too long. Second, structural shifts in the economy, which often accelerate during recessions, may eventually require employment adjustments. Lastly, hourly flexibility works both ways: firms may target lower employment levels in the future assuming that higher demand can temporarily be accommodated by increases in hours worked. This suggests that deterioration in labor market outcomes may yet occur.


supported in part by the Kurzarbeitergeld.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: Haver and OECD.
1/ Recent statistical changes have contributed to smaller measured unemployment, but even accounting for these changes, the overall picture of a historically mild response in unemployment remains.2/ Short-time subsidies cover up to 67 percent of a worker’s lost income. Recent changes included an extension of the maximum duration to 24 months and increased coverage of firms’ social contributions.

Consumption tends to fall when un employment increases.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: IMF, WEO.

C. Credit Growth

14. With both credit supply and demand weak, there is little clear evidence of a credit crunch at the current juncture. While banks have deleveraged their balance sheets since the start of the crisis and bank lending surveys provide mixed signals, corporate credit has declined broadly in line with GDP, suggesting that demand factors have been at play, too. Empirical analysis by the authorities and staff confirms this view.3 Easing the pressure, large corporations have relied on the bond market to roll over existing debt, and there are indications that small and medium-sized firms (SMEs) benefited from access to smaller banks that have kept credit lines open. Still, public concern about reduced access to credit for SMEs exists. The 2009 stimulus package included a program to support SME credit supply by shifting credit risk to the Kreditanstalt für Wiederaufbau (KfW, a federal public bank).


Credit to corporations has fallen in line with GDP.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: Haver.

15. With looming bank write-downs and pending regulatory demand for additional capital, the authorities share the staff’s concern that credit supply could run short when the recovery matures. While losses from securitized products have likely reached their peak, additional losses on non-performing loans, which follow GDP growth with a lag, could be significant. The Bundesbank estimates that by end-2010 German financial institutions are likely to write down another €50 billion to €75 billion from bad loans, adding to asset-related losses of €10 billion to €15 billion.4 This implies that about half of total losses have been written off, a ratio that tallies broadly with the IMF’s October 2009 estimates for European banks overall.5 These losses—together with tighter capital regulations—will constrain credit supply during the recovery. Indeed, empirical evidence suggests that, in Germany, lending growth during the crisis has been positively related to initial bank capital, suggesting that capital could be a constraint on lending moving forward (Box 3).


Negative bank credit shocks reduce private consumption and fixed investment

(Change in Logs)

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: Bundesbank, GEE, and IMF staff estimates.Each figure reports the cumulative impulse-response of a one standard deviation negative bank credit shock on respectively consumption and on fixed investment. Each VAR, described in Box 3, is estimated over the period 1991:Q1-2007:Q4, and includes log (bank credit), log (employment), log (foreign import demand for German exports), and log (REER).

16. Weaknesses of bank balance sheets could therefore hinder the recovery. Staff analysis suggest that negative shocks to credit supply would have large and lasting negative effects on real economic activity, in particular on gross fixed capital formation and private consumption. Thus, the possibility of a credit crunch is an important downward risk to the recovery.

Bank Balance Sheets and the Recovery

Since the start of the financial crisis, bank capital has weakened credit supply, adding to the decline in credit. Following the approach of Bernanke, Lown and Friedman (1991), staff estimated a relationship between lending Estimated impact on annualized quarterly lending growth of a one standard deviation increase in: growth and a measure of capitalization, defined as the ratio of capital to assets.1/ The analysis is based on a panel of quarterly data over the period 2000-2009 in which bank balance sheets are aggregated in five categories (large commercial banks, other commercial banks, Landesbanken, savings banks, cooperative banks, and mortgage banks), and control variables include two measures of asset composition (cash over assets, and loans over assets). The results suggest that, since the crisis began, bank capital has become a constraint on lending growth, in contrast to the pre-crisis period. Moreover, the capital constraint appears to be stronger for the large commercial banks than for other banks. The effect of an increase in capital/assets on lending growth is economically significant, especially for the large commercial banks.


Estimated impact on annualized quarterly lending growth of a one standard deviation increase in:

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

A reduction in bank credit affects German macroeconomic activity significantly by reining in private consumption and investment. Employing a simple time series analysis, staff assessed the impact of a reduction in bank credit on GDP, private consumption, and gross fixed capital formation.2/ The quantitative effects of a reduction in bank credit on private demand are large: the estimated effects imply that a 1 percent reduction of bank lending would reduce consumption and investment by respectively 1.2 percent and 2.8 percent (text figure).

1/ Bernanke, Lown, and Friedman, 1991, “The Credit Crunch,” Brookings Papers on Economic Activity: 2, pp. 205–248.2/ Specifically, three vector auto-regressions (VARs) of GDP, private consumption, and gross fixed capital formation, respectively, on bank credit were estimated, controlling for employment and a measure of import demand for German exports. The VARs are estimated at a quarterly frequency over 1991–2007.

D. Potential Growth

17. The authorities agree that the crisis has temporarily weakened Germany’s growth potential. Staff research suggests that potential growth has dropped to ⅓ percent following several quarters of very weak investment and the scrapping of excess capacity in some areas (Box 4). The damage would have been more severe but for the slow adjustment of employment. Mirroring the labor market outlook, there are upside and downside risks. For example, the deterioration of the labor market could lead to higher and more long-term unemployment than anticipated, which could slow the projected gradual recovery of potential growth to its estimated longer-term value of around 1¼ percent. But it seems equally likely that labor market conditions could develop better than expected.


Potential GDP will return to pre-crisis growth but at a lower level.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: Global In sight; and staff projections.

18. The slower expansion of potential growth will have repercussions for the speed of the recovery from the recession. Real activity is likely to run into capacity constraints earlier than otherwise, possibly leading to factor market tensions. This could trigger unwanted upward wage and price pressures.

E. Inflation

19. Against this background, inflation is expected to continue its gradual rise from the very low levels reached recently. Helped by the turnaround of global commodity prices, headline inflation is back in positive territory, averaging 0.2 percent in 2009, compared with core inflation of 1.2 percent. With the level of actual output substantially below potential, headline inflation is projected to further increase only slowly, averaging about 0.9 percent in 2010 and 1.0 percent in 2011—an outlook broadly shared by the authorities.


Core inflation has remained stable throughout 2009.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: Eurostat, Haver, and Statistisches Bundesamt.

The Effects of the Crisis on Potential Growth

The financial crisis and the long recession have combined to lower Germany’s potential GDP growth in the near and the medium term, but its longer-run trend will be little affected.1/ Staff sees potential growth around 1.2 percent in the longer run (although there are indications that long-run growth could be on a downward path, reflecting, among other things, Germany’s aging population). However, the impact of the crisis is likely to be shorter lived than elsewhere. While extraordinary financial sector productivity gains and profits added significantly to pre-crisis financial sector growth in some economies, Germany’s financial sector showed little sign of overheating prior to the crisis. Thus, there is less need for adjusting long-run growth expectations in its aftermath.


Financial sector growth has been limited in Germany.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: REO Europe (Oct. 2009) and EU KLEMS Database (Nov. 2009)

But the crisis will have a temporary negative impact on potential growth in the medium term. Like elsewhere, the effect arises from reductions in available input factor growth, through lower investment and a possible increase in structural unemployment, as well as from a reduction in productivity growth, especially labor productivity. Staff expects labor productivity to increase as firms adjust their workforce (see Box 2), and investment to pick up as the recovery matures, which will eventually increase potential growth back to pre-crisis levels. The implied permanent loss in the level of potential output is in line with the available cross-country evidence on the medium-term impact of recessions accompanied by financial crises on growth (see WEO October 2009, Chapter 4).


In Germany and elsewhere, the crisis’ impact on potential has been proportional to its impact on GDP.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: IMF, WEO.Note: Data are calculated as the percent difference between projections for 2013 in the October 2009 WEO relative to those in the April 2008 WEO.
1/ This assessment combines judgment and technical analysis based on a Kalman filter methodology taking into account trend and cyclical variables correlated with potential growth and the output gap, respectively, including population growth, productivity, employment, investment and inflation.

III. Fiscal Policy: From Stimulus to Consolidation

20. Fiscal policy has been counter cyclical. During 2008 and 2009, the authorities legislated fiscal stimulus measures amounting to 1.5 percent of GDP for 2009 and 0.4 percent of GDP for 2010; implementation lags suggest that a larger share of the measures will become effective this year. It is too early to evaluate the effectiveness of the stimulus overall. However, there are indications that the cash-for-clunkers scheme had a pronounced impact on private consumption during the first half of 2009—although the stark decline in car sales after the scheme’s expiration suggests that much of this effect was due to existing demand plans being moved in time (Box 5). The new government is committed to executing the remaining stimulus in the pipeline, and has added ¼ percent of GDP of new measures consisting of various tax rebates for businesses and higher family benefits for 2010, bringing the overall stimulus for this year up to 0.7 percent of GDP. This is broadly consistent with the Fund’s advice to maintain fiscal support until the recovery is firmly in place, even though the composition casts doubt on its effectiveness. In addition, the government’s coalition agreement envisages permanent income tax cuts of about 1 percent of GDP in 2011.

Fiscal Overview

(percent of GDP)

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Source: Authorities and IMF staff.

Including local governments.


Germany’s fiscal stimulus has been large, reflecting the size of the economic shock…

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: IMF, WEO and staff estimates.1/ Sum of fiscal stimulus in 2009 and 2010 (Percent of GDP).

…and a beneficial fiscal position at the start of the crisis.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: October WEO, updated figures for Germany.

Car-Scrapping Program

The Cash-for-Clunkers scheme (CFC, “Umweltprämie”) offered a subsidy of €2,500 for the purchase of new cars between January and August 2009. Following an overwhelming number of applications, the scheme’s value was increased from the initial €1.5 billion to €5 billion (0.2 percent of GDP). Private consumption of cars jumped in Q1 and Q2 of 2009.

Staff estimates suggest that the CFC scheme boosted private consumption growth by 1.1 and 0.4 percentage points (qoq) in 2009:Q1 and Q2, respectively. A simple model explains the historical behavior of private expenditure on cars with a lag and disposable income. The spike in car sales during the first half of 2009 cannot be explained by the model. A dummy variable attributes a car consumption growth boost of 20 percentage points in each Q1 and Q2 to the CFC scheme. This effect translates into a positive contribution to total private consumption growth of 1.1 and 0.4 percentage points in 2009:Q1 and Q2, respectively.


Private consumption of cars

(qoq growth, sa)

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: Authorities and IMF staff calculations.

Estimates suggest that falling car sales already lowered private consumption growth by 0.1 percentage point in Q3—but experience with the 2007 VAT increase suggests that more weakness is to come. In the run-up to the VAT increase in January 2007, car consumption jumped in late 2006, but the sharp decline in 2007:Q1 indicates that the previous increase was mostly driven by advanced car purchases.1/ Consistent with the experience of the VAT episode, car sales have already started falling in 2009:Q3, shaving 0.1 percentage points off private consumption growth. More recent data indicate that car sales have continued to decline, contributing to weaker private consumption.

1/ The regression result shows that the announcement of the VAT increase raised car consumption growth by 9 percentage points in each 2006:Q3 and Q4, before the VAT increase reduced car consumption growth by 17 percentage points in 2007:Q1.

21. Consequently, the fiscal position has weakened markedly. Following a balanced budget in 2008, the general government deficit reached an estimated 3.3 percent of GDP in 2009 and is projected to increase to 5½ percent in 2010—nearly twice the deficit limit set by the European Union’s Stability and Growth Pact (SGP). The increased deficit reflects the additional budget measures, the fiscal consequences of the anticipated weakening of the labor market, and cyclically weak tax revenues. Taking into account the fiscal costs associated with the financial sector support packages, the gross debt ratio is set to rise from 65 percent of GDP in 2007 to 77 percent in 2010.

22. The authorities agree that fiscal consolidation needs to start as soon as the recovery has firmed up—which is projected for 2011. With public debt on a rising path, contingent liabilities associated with financial support measures, and private sector growth expected to become self sustaining by 2011, fiscal consolidation should become a priority.

23. The authorities are firmly committed to meeting their medium-term fiscal targets. To fulfill the SGP requirement, the general government deficit will have to decline to 3 percent of GDP by 2013. By 2016, the general government budget will have to be close to balance, reflecting the limits Germany’s new constitutional rule (“Schuldenbremse”) and Medium-Term Objective (MTO) specified in the latest Stability Report impose on the structural deficits of the federal government and the Länder, respectively.6 Meeting these targets, which will require efforts from all levels of government, would allow Germany to regain the fiscal space lost to the crisis and prepare for the rising costs of its aging population.


General government budget balance: alternative scenarios

(percent of GDP)

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: IMF staff calculations.1/ Annual structural adjustment of 0.6 percent of GDP; tax cuts in 2011.2/ Annual structural adjustment of 0.4 percent of GDP; tax cuts in 2011.3/ No structural tax or expenditure adjustment.

24. Achieving these objectives will be a formidable task. While the economic recovery and the withdrawal of the stimulus measures will help reduce the general government deficit, additional adjustment is needed. According to staff’s analysis, reaching the SGP goal will require an annual structural consolidation effort at the general government level of ½ percent of GDP in 2011-13.7 Complying with the constitutional fiscal rule and MTO will require further annual structural adjustment of ¾ percent of GDP through 2016. Both calculations include the planned tax cuts in 2011. The required fiscal efforts are large and comparable to the re-balancing of the public finances after German unification, and the pre-crisis drive for a balanced budget.

Germany: Historical Episodes of Consolidation

(percent of GDP)1/

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Source: IMF staff calculations.

Figures refer to the general government.

25. Formulating a credible fiscal adjustment strategy—focused on expenditures—and implementing it starting in 2011 will be important. Expenditure-based consolidations tend to be larger and more enduring,8 and the authorities agreed that such an approach was preferable. International evidence also shows that fiscal adjustments cause the smallest contractionary effects when driven by reductions in current spending.9 The authorities agreed that measures introduced during the crisis need to be withdrawn as planned, but additional efforts will be required. While progress has been made in reducing subsidies under the previous government, staff stressed that the planned further systematic examination of subsidies (for example, in agriculture or mining) can yield budgetary savings. Staff also saw it as crucial to strictly adhere to the agreed-upon adjustment mechanisms for pension benefits and the gradual rise in the retirement age. The ongoing effort to realize potential savings in the health care system (for example, by limiting spending on non-generic pharmaceuticals) should also help.

26. But the authorities are well aware that the need for consolidation might exceed the scope for expenditure cuts, in which case revenue measures will also be needed. Staff suggested that a first step could be to broaden the VAT tax base by eliminating exemptions, including those recently introduced, and increasing coverage. Staff also recommended reviewing income tax exemptions. If tax rate increases were unavoidable, higher VAT rates would prop up revenues at the federal and Länder levels, and a reform of the property tax could support local finances. Also, an increase of contribution rates to the unemployment insurance would remove the need for repeated federal government support—a proposal that is under discussion.

27. In this context, tensions in the fiscal plans for 2011 need to be resolved. The coalition agreement includes a permanent income tax cut of about 1 percent of GDP. The authorities pointed out several arguments in its favor: well-timed tax cuts can help sustain private demand and the recovery; the implied lowering of marginal tax rates could increase incentives to work; and the envisaged simplification of the income tax system (including a move from the existing linearly increasing income tax schedule to one with stepwise constant rates) promises further efficiency gains. While agreeing with these potential benefits, staff noted that the impact on labor supply may be small and that the proposed income tax schedule could create adverse incentive effects, such as those associated with bunching around the tax rate steps. Moreover, the tax cuts in 2011 would add to the already elevated debt level at a time when the recovery has likely already firmed, giving them a distinctly pro-cyclical character. This suggests that any tax measure should be carefully designed to maximize its intended efficiency impact and should be implemented only if compensating budgetary measures were taken to ensure compliance with the medium-term fiscal targets.

28. The authorities are well aware that a successful fiscal exit will not only establish the credibility of the new national fiscal framework, it will also help anchor fiscal policy in the euro area. Germany’s fiscal actions matter in Europe because of the country’s relative size and because, as in the past, they could set an example for fiscal consolidation for the rest of Europe (Box 6). This would reduce the risk of an undesirable policy mix of tight monetary and loose fiscal policy (which tends to increase interest rates and crowd out private demand) in the euro area, which in turn would weaken growth in Germany. Conversely, a failure to consolidate the public finances in Germany would damage the national and European fiscal frameworks.

IV. Financial Sector

A. Completing the Banking Consolidation

29. The health of the financial sector has improved, but time is running short for dealing with the remaining problems and risks. The steepening yield curve, the improving economic outlook, and the authorities’ financial sector measures have benefited banks. Some of Germany’s larger banks have deleveraged their balance sheets and added to their capital. Still, the remaining sizable write-downs, along with risks to the recovery and banks’ exposure to emerging and Southern European markets, create vulnerabilities. With the expected tightening of euro area liquidity, the window for resolving remaining financial sector problems is closing fast. The sunset clauses for new public support through the Sonderfonds Finanzmarktstabilisierung (SoFFin) by end-2010 add to the urgency (Box 7).

30. Recognizing capital needs at the individual bank level and acting upon it will be key. As the authorities pointed out, the voluntary public recapitalization option offered by SoFFin has been helpful in this regard. However, fewer institutions than initially expected have made use of the offer, suggesting—in staff’s view—that more forceful incentives to strengthening capital buffers might be needed. Stronger institutions could make use of the normalization of equity markets. Weaker banks will have to accept the conditionality of SoFFin’s support, or face resolution. In line with the principles established by SoFFin, public support will be conditional on viable business models—a condition particularly relevant for the Landesbanken sector.

Fiscal Spillovers in the Euro Area

Staff’s research shows that Germany’s fiscal actions have had positive spillovers into member states since the creation of EMU.1/ Empirically modeling the reaction of fiscal indicators to a number of economic and policy variables for a panel of 11 euro area members, staff show that Germany’s discretionary fiscal policy has had a strong and robust influence on discretionary fiscal actions in the rest of the euro area since 1992. The text chart displays the estimated policy spillover parameter and its error bands—it measures the reaction of the average euro area country to changes in Germany’s fiscal policy across different time samples using a rolling ten-year window.


Fiscal Spillovers Parameter Rolling regression with moving 10-year window

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: Mody and Stehn, forthcoming.

Fiscal credibility seems to explain part of the effect. Indeed, the pattern of country responses to Germany’s actions suggests that the wish to signal credibility plays a role. Countries with higher political instability and more acute economic vulnerabilities have responded more strongly to Germany’s actions. This effect was particularly strong during periods of German fiscal consolidation.

1/ See Mody and Stehn, Fiscal Policy in the Euro Area: Does Germany Play a Leadership Role? IMF Working Paper, forthcoming.

31. The larger public banks remain an area of particular concern. The financial crisis has revealed serious and systemic risks to financial stability in the Landesbanken sector. After government help in various forms for various Landesbanken (see text figure), Germany’s largest Landesbank, West LB, will undergo more substantial restructuring. About one third of its balance sheet (€85 billion, including structured products) will be transferred to a “bad bank,” with the remaining core bank receiving about €3 billion public capital from SoFFin, initially as silent participation. Bayern LB’s financial position has been weakened by its past, and costly, ownership of Austrian Hypo Group Alde Adria.

The German Financial Market Stabilization Fund (SoFFin)

The Sonderfonds Finanzmarktstabilisierung was set up in October 2008 and is administered by the Agency for the Stabilisation of the Financial Markets (Bundesanstalt für Finanzmarktstabilisierung, FMSA). Its purpose is to facilitate financial sector stabilization measures supporting financial institutions (such as banks, insurance companies, pension funds, investment companies, and special purpose vehicles) based in Germany. Stabilization measures are decided by the Ministry of Finance (which delegated certain decisions to FMSA), and the Ministry regularly informs a special parliamentary committee. In its operations, SoFFin draws on some support from the Bundesbank and external expertise.

The available stabilization measures comprise guarantees, recapitalizations, and the transfer of risky assets, including “bad banks.” The total volume of these measures is capped at €480 billion, with up to €400 billion available for guarantees for interbank loans and bank-issued debt with a maturity of generally up to 3 years, and €80 billion for the recapitalizations and the assumption of risk associated with certain assets. The federal government provides the funding of the SoFFin. After the liquidation of the SoFFin, the remaining position is to be divided to 65 percent to the federal government and 35 percent to the states (capped at € 7.7 billion, though costs associated with the Landesbanken are to be borne in full by the relevant states).

Financial Crisis Measures in Comparison 1/

(In percent of GDP)

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Sources: WEO; IFS; and IMF staff estimates.

As of end-December, 2009 (Germany) and end-August, 2009 (others).

Notes: Pledges based on announcements by official agencies, supplemented by information from financial market sources. Guarantees cover asset loss or financial institutions’ debt, such as senior unsecured debt. Recapitalization includes purchases of shares or hybrid capital instruments that constitute tier I capital. Asset swaps and purchases include government purchases of assets held by financial institutions or exchange for government debt.

The uptake of SoFFin financial sector support measures has been large. By December 2009, about 40 percent of the available funds had been used (40 percent of the guarantees and 37 percent of the other measures) and another 19 percent of the available fund had been requested.

Besides Germany, the U.K. and Switzerland have established specific entities (with a temporary mandate) to resolve the distress of its financial system. U.K. Financial Investments Limited was established in November 2008 as a company wholly-owned by the Government. Its aim is to manage the Government’s equity participations in financial institutions at arm’s length and on a commercial basis, to ensure financial stability, and to act in a way that promotes competition. Switzerland has established a Stabilization Fund as a separate entity that is closely linked to the Swiss National Bank to handle the illiquid assets of a large bank. Other countries that have experienced highly adverse shocks to their financial stability have handled the crisis with existing institutions, for instance in the U.S. through the Federal Reserve and the FDIC.

32. This suggests that consolidation of the Landesbanken sector should be a policy priority. The authorities are well aware of—and staff has noted in the past—many of the sector’s underlying problems, including the structural unprofitability, weak governance, and insufficient risk control that are burdening many institutions.10 Staff noted that the structural unprofitability will remain even as the outlook improves: with their high cost structure and lack of a viable business model, some Landesbanken will continue to show a tendency for excessive risk taking in search of profits. Thus, despite initial steps towards restructuring, much more needs to be done to prevent the sector from being a continuous drain on the public finances and a source of financial instability for Germany. While the authorities supported the need for significant consolidation of the sector, they also stressed that the ownership of the Länder limits the influence of the federal government on the process. The authorities and staff saw the Landesbanken’s wholesale banking function for Sparkassen as a basis for consolidation, with staff suggesting a single institution. Any remaining Landesbanken would need to have effective governance and viable business models, with an alternative private ownership structure.

Banking Sector—Performance and Soundness Indicators: Selected Countries, end 2008

(In percent)

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Sources: Bankscope; and IMF staff calculations. U.S. and German data shows consolidated reports for banking groups, other data also unconsolidated reports for other banks. The aggregate capital adequacy ratio and Tier 1 ratio are the weighted average of individual banks CAR and Tier 1 ratio with 2008 assets as weighs, and for the 25 largest banking groups in each country for which 2008 consolidated accounts are available.

33. Quickly solving the remaining financial sector problems at the individual bank level will also allow exiting from blanket measures. Measures such as the support for bank funding offered by SoFFin and the government’s public commitment to fully protect household deposits can distort risk-taking incentives and prevent market normalization. This calls for an exit as soon as all known and anticipated recapitalization needs have been met. The forthcoming FSAP Update requested by the authorities and scheduled for late 2010 can be helpful by shedding light on the financial sector’s health in the absence of government support. Enhanced surveillance of the German banking sector would profit from more comprehensive and timely data and transparent reporting.

Germany: Key Measures in Response to the Financial Crisis

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Sources: Authorities; and IMF staff.

34. It will be important to coordinate the exit from these financial sector measures internationally. For example, an uncoordinated withdrawal or amendment of deposit guarantees at the national level could trigger unwanted cross-border capital flows—similar to the early crisis phase, when highly liquid funds chased the highest deposit guarantee across Europe. To limit these risks, Germany will benefit from (and could be part of) a coordinated exit at the EU level.

B. The Financial Stability Framework

35. The authorities are moving to overhaul the financial stability framework. Key elements of the reform are banking supervision and the bank resolution regime, while further changes to the fragmented deposit insurance system are not on the agenda. Ongoing EU reforms are providing the backdrop to the German efforts.

36. The government plans to consolidate all prudential banking supervision into the Bundesbank. Currently the Bundesanstalt fur Finanzdienstleisungsaufsicht (BaFin, the consolidated supervisor for the German financial sector) and the Bundesbank share duties for bank supervision. The Bundesbank performs on-site supervision under instructions issued by BaFin, but BaFin can commission special audits of banks and has overall responsibility for the supervision of banks. The arrangement has been criticized—including by staff—as duplicative and creating coordination and informational issues, creating delays in taking enforcement actions, and weakening accountability and potentially leading to poor decision making. Against this background staff welcomed the planned reform as a step in the right direction.

37. The authorities are discussing a variety of organizational models to implement the reform. Staff stressed that no one arrangement has worked consistently better across countries in preventing the crisis.11 However, the crisis has also highlighted the need for any model to ensure the incentives and capability to identify and address systemic risks. To this end:

  • The authorities agreed that having one national agency with a clear mandate for macroprudential oversight and monitoring systemic risk would have benefits. The Bundesbank is the natural choice in this regard, given its experience in banking supervision and financial stability analysis. The discussion about the Bundesbank’s sectoral coverage is ongoing, however. In staffs view, placing prudential supervision over the entire financial sector—in particular not only banking but also insurance given their interconnectedness in Germany—under the Bundesbank would facilitate both this process and the Bundesbank’s ability to represent Germany on the proposed European Systemic Risk Board. BaFin would then become the market conduct supervisor, with responsibility for securities firms and markets and consumer protection for the entire financial sector—an arrangements resembling the so-called twin peaks model.

  • Regardless the specific responsibilities given to the Bundesbank, staff stressed the resulting body would have to be both accountable and operationally independent to deliver effective supervision.

  • The authorities stand ready to manage the transition risks to avoid supervisory lapses. Given the possibility that the merger and reorganization could well distract personnel from their primary mission, staff suggested it was critical to clarify early the form of the final reorganization and prepare for speedy implementation by early 2011.

38. The authorities also seek to strengthen the legal framework for bank resolution. The global financial crisis has reinforced the need for countries to have strong and effective regimes for bank resolution. Building on the temporary measures taken with the creation of SoFFin, the authorities have begun to develop a legal framework for resolving systemically important banks in an orderly fashion. As discussed at the European level, this framework should allow for bridge banks and transactions involving the assumption of liabilities and the purchase of assets. While the authorities saw little need for a special regime to allow for the orderly exit of non-systemic banks, staff stressed the slowness and potential disruptiveness of existing corporate insolvency procedures. The authorities agreed that having a permanent bank resolution regime in place by early 2011 would have advantages, given the sunset provisions for SoFFin. In case of a delay, staff recommended SoFFin’s powers should be extended as long as needed.

39. The crisis has exposed long-standing limitations of the German deposit insurance regime, strengthening the case for more fundamental reform. As staff has highlighted in the past, German deposit insurance is highly fragmentized, reflecting the public-private mix of the banking system.12 Commercial banks combine a statutory scheme providing coverage of €50,000 with additional collective arrangements. Cooperative banks rely on collective arrangements and Sparkassen and Landesbanken on a combination of collective arrangements and support from their public sponsors—and neither group is currently subject to a statutory scheme. While the authorities saw the existing regime as adequate, staff pointed out the lack of transparency and legal certainty and stressed that the high coverage can be difficult to maintain without public support—a point vividly illustrated by the need for a €6.7 billion SoFFin guarantee for the commercial banks’ deposit protection scheme during the crisis. In addition, the association-sponsored deposit protection schemes rely largely on after-the-fact contributions from members at the time of stress, which can exacerbate a crisis. With the EU-initiated further increase of statutory deposit insurance coverage to €100,000 next year, staff saw merit in creating a unified fund for deposit insurance spanning the entire banking system.

V. Adjusting Structural Policies

40. With the recovery firming up, labor policy measures and state aid introduced to soften the crisis’ impact have served their purpose. The enhancements of Kurzarbeit during the crisis, and the support for struggling corporations through targeted KfW credit programs and the Deutschlandfonds (a credit fund installed as part of the stimulus measures), have contributed to limiting the initial crisis impact on employment. This has helped the hard-hit manufacturing sector—with some struggling corporations benefiting both from credit arrangements and the short-time work scheme. But the authorities are well aware that it will be important to adjust these policies to the cycle to avoid impediments for structural change and longer-run growth. For example, industry analysts argue that the car industry in Western Europe is characterized by excess capacity beyond the immediate effects of the crisis.13 Thus, it will be crucial to draw a line between smoothing the impact of the shorter-term repercussions of the global recession and preventing what could be a necessary adjustment to longer-term trends in demand. Staff therefore supported the government’s intention to adjust the conditions of the Kurzarbeit scheme in line with the pace of the recovery.


Employment protection remains high…

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: OECD.

…and so does services regulation.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: OECD.

41. The authorities agreed that payoffs from adjusting structural policies more generally are high—but saw little opportunity for major additional reforms in the near term. Given the projected increase in unemployment, the damage from the crisis to potential growth, and the expectation of more moderate export demand, it will be essential to add to the gains from past reforms. In particular, further increasing labor market flexibility through decreasing both legal and labor-court based employment protection would support the reallocation of workers across sectors, while tackling remaining obstacles to service sector growth would boost labor demand. The product market reforms currently discussed by the authorities—ranging from enhanced powers for the competition authority to measures to enhance competition in network industries—will also be beneficial. Simultaneous reforms in all areas are promising additional benefits, as firms operating in more competitive product or services markets tend to react more strongly to labor market reforms than others. While agreeing that there was scope for additional reforms, the authorities noted the political window to implement had narrowed, with the current public debate focused more on the costs than the benefits of past structural reforms.

VI. Spillovers

42. Compared to the other large European countries, Germany is a remarkably open economy and particularly exposed to foreign shocks. Germany is highly integrated into global trade, and even more into the intra-European and euro area flow of goods and services. External volatility therefore adds considerably to the volatility of GDP overall. Germany’s larger banks, too, operate globally and across Europe’s financial market. Between 2000 and the first quarter of 2008 alone, foreign claims of German banks rose by the equivalent of 37 percentage points of GDP, and foreign exposure remains high despite the deleveraging during the crisis period (Box 8). Real and financial links to emerging Europe are substantial, including through export demand, the integration of manufacturers in the German supply chain, and banking exposure. German banks have close to 5 percent of their foreign portfolio invested in Central and Eastern European countries, which exceeds the investment by banks in the U.S., the U.K., or France.


Germany is more exposed to EU and non-EU trade shocks than its larger neighbors, but financial openness is average.

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: IMF, DOT; and staff calculations.

Significant write-downs of German banks’ foreign exposures to Southern Europe or Central and Eastern Europe would likely feed back into a deleveraging and contraction of these exposures. 1/

(Billions of U.S. dollar)

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: BIS; and IMF staff calculations.1/ BIS consolidated banking statistics and IMF staff simulations based on a model of international banks’ deleveraging developed for the purpose of the Vulnerability Exercise for Advanced countries and the Early Warning Exercise. The reduction of foreign claims of international banks is simulated based on 10 percent write-offs of exposures to the set of countries considered, and takes into account banks’ initial capital buffer.2/ Greece, Italy, Portugal, and Spain.3/ Albania, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Rep, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Russia, Serbia, Slovakia, Slovenia, and Ukraine.

43. This reinforces the case for strengthening domestic sources of growth, which could also contribute to lower current account imbalances—both globally and within the euro area. Staff agreed with the authorities that the rebalancing should not occur through policies to weaken German competitiveness—a move likely to reduce euro area competitiveness overall. Within the euro area relative prices will have to adjust to prevent continued imbalances and safeguard growth. For Germany, the way forward would be additional labor reforms and efforts to bolster service sector activity to aid long-run growth. In addition to benefiting Germany more generally, this could help to reduce Germany’s current account surpluses by increasing imports. To the extent that strengthening domestic sources of growth also reduced the impact of the ups and downs of global demand on economic activity, consumption could increase as well, as households will feel less need to add further to their buffer-stock savings—a link stressed in past Staff Reports.14 The authorities agreed in principle but repeated that the scope for the necessary reforms might be limited.

Foreign Exposure of German Banks

Prior the crisis, foreign claims of German banks grew at a rapid pace. From 2000:Q1 to 2008:Q1, foreign claims of German banks rose by 160 percent to about $4.7 trillion (a change in the foreign claims to GDP ratio of about 37 percentage points). About half of the build-up of foreign claims of German banks during this period went to the euro area and to the U.S., while emerging markets accounted for 8 percent of the increase.

The crisis triggered a deleveraging partly driven by risk perceptions. Between March 2008 and the end of June 2009, foreign claims of German banks contracted by $1.2 trillion—exceeding the decline in other advanced countries.1/ The bulk of this reduction occurred vis-à-vis other advanced countries, in particular with the U.S. and the euro area. Within the euro area, Southern Europe—namely Greece, Italy, Spain, and Portugal—took a significant part of the adjustment. At the same time, claims toward Central and Eastern Europe (CEE) contracted only modestly, possibly as a result of the Vienna initiative or of banks’ objective to maintain their presence in CEE countries.


Foreign Claims of International Banks

(In billion of US$)

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Source: BIS, Consolidated Ban king Statistics.

But German banks remain exposed to foreign risks. Simulation exercises suggest that German banks could suffer significant losses from commercial real estate investments in the U.S. and Spain, Geographical Distribution of Foreign Claims of International Banks (In percent of total, unless otherwise indicated) and more generally from exposures to Southern Europe. The simulations also suggest that a reassessment of risks associated with claims on Southern Europe could have a large impact on capital flows within Europe, as German (and also French) banks would significantly reduce their foreign claims to restore capital ratios (see figure in main text).2/

Geographical Distribution of Foreign Claims of International Banks

(In percent of total, unless otherwise indicated)

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Source: BIS Consolidated Banking Statistics.Note: Southern Europe includes Greece, Italy, Portugal, and Spain. Emerging markets are countries included in the Vulnerability Exercise for Emerging Markets.
1/ After the third quarter of 2008 U.S. banks aggregate foreign claims rose as a result of the inclusion of new reporters, including in particular the former investment banks.2/ Based on the methodology of the IMF’s Vulnerability Exercise for Advanced Countries (see the companion paper on methodology and theoretical background, Fall 2009).

External volatility tends to exceed domestic, with possible repercussions for investment. 1/

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: Authorities and staff estimates.1/ Volatility is calculated as the standard deviation of annual growth rates around their mean.

44. Germany will benefit from such policies more than less open economies. In highly integrated markets, spillovers work both ways. As a consequence, Germany will reduction of global current account imbalances, profit more than less open economies from a which will reduce the risk of rapid or excessive exchange rate movements that tend to hurt foreign trade. Similarly, Germany stands to gain from the feedback effects of successful fiscal consolidation. As argued earlier, because Germany often sets the tone for fiscal policy in the EU, it can instill credibility into the SGP framework and help avoid an undesirable macroeconomic policy mix and higher-than-necessary interest rates that would hurt the upswing. Also, ensuring the health of German banks operating across Europe and strengthening financial stability institutions within the developing EU framework will ultimately help to stabilize the recovery in Germany’s main markets.


Among many advanced economies, larger service sectors are associated with smaller current account surpluses.1/

Citation: IMF Staff Country Reports 2010, 085; 10.5089/9781455202614.002.A001

Sources: Haver; Eurostat; and IMF staff calculations.1/ Panel data for 1990-1999 and 2000-2009, respectively, filtered for fixed time and country effects.

VII. Staff Appraisal

45. The recovery underway is likely to be moderate, with predominantly downside risks. Muted euro area expansion and the restraint of U.S. consumers will limit Germany’s export growth, while domestically consumers will remain cautious given the expected increase in unemployment and moderate income gains, and remaining banking problems will contain credit supply. GDP growth could also be lower because of setbacks to world trade or the domestic financial system.

46. The policy challenge is managing ongoing risks while preparing to unwind the extraordinary measures introduced during the crisis Fiscal policy will have to transition from supporting the recovery to credible consolidation, financial sector policies from balance sheets repair to improvements of the stability framework, and labor market and structural policies from employment smoothing to fostering domestic growth.

47. Fiscal consolidation needs to start as soon as the recovery has firmed up The 2010 budget appropriately provides stimulus for a still fragile recovery. As a consequence, the general government deficit is estimated to rise in 2010 to nearly twice the limit set by the SGP. Moreover, the federal structural balance is significantly below the target set by the new constitutional rule for 2016. With public debt rising and private sector growth expected to be self-sustaining by 2011, consolidation should become a priority.

48. Germany’s commitment to the SGP and its new constitutional rule is welcome—and has potential benefits for Europe. Meeting these targets would allow Germany to regain fiscal space and prepare for the rising costs of its aging population. Moreover, Germany’s actions also matter for Europe because, as in the past, German consolidation could set an example for other countries. This would help avoid an undesirable policy mix of tight monetary and loose fiscal policy in the euro area.

49. Meeting the consolidation targets is a formidable task

  • Fulfilling the government’s fiscal targets, including the SGP and the new constitutional rule, will require sizable structural adjustment between 2011 and 2016. Thus, a credible plan, preferably focused on expenditures, is needed fast. In this context, the tensions in the fiscal plans for 2011 should be resolved by designing the planned tax cuts to maximize efficiency and be implemented only with compensating budgetary measures to meet medium-term fiscal objectives.

  • Expenditure savings are available including from a systematic examination of subsidies and in the health care system. Agreed-upon adjustment mechanisms for pension benefits and the gradual rise in the retirement age need to be implemented.

  • Should revenue measures have to be part of the solution, eliminating exemptions in income and VAT taxes should have priority before higher VAT rates. A reform of the property tax could support local public finances. Higher unemployment insurance contribution rates would remove the need for repeated government support

50. The health of the financial sector has improved, but time is running short for dealing with the remaining problems and risks, in particular in the ailing Landesbanken sector. Strengthening capital buffers should be a priority for most banks. Despite initial steps towards restructuring, much more needs to be done to prevent the Landesbanken from being a continuous drain on the public finances and source of financial instability. Major consolidation into one wholesale bank for the Sparkassen is a priority, and remaining institutions should have to prove their structural profitability under an alternative ownership structure. Enhanced surveillance of the German banking sector would profit from more comprehensive and timely data and transparent reporting.

51. The government’s commitment to make the Bundesbank the sole prudential bank supervisor is welcome. The reform would improve the accountability and enforcement of banking supervision. Moreover, choosing the Bundesbank as single agency for macroprudential oversight and monitoring systemic risk will provide for the necessary capability and incentives to identify and address systemic risks—in particular if prudential insurance supervision was added to its portfolio. Either way, effective supervision will require that the resulting institution be both accountable and operationally independent. The transition risks stemming from the reform need to be managed to avoid supervisory lapses.

52. There is a need for a strong and effective bank resolution regime. Against the background of the ongoing discussion at the European level, the authorities have started to develop a legal framework for orderly resolving systemically important banks. Any such regime should include among its tools bridge banks, transactions involving the assumption of liabilities, and the purchase of assets. It will also be important to develop a similar solution for non-systemic banks. The new regime should be in place before the temporary resolution framework provided by SoFFin expires by year-end. If necessary, SoFFin’s powers should be extended until the permanent solution is in place.

53. The crisis also highlighted the need to overcome the well-known limitations of Germany’s fragmented deposit insurance system The EU-initiated increase of deposit insurance coverage to €100,000 next year will be an opportunity to create a unified deposit insurance fund spanning the entire banking system. This would introduce welcome transparency and legal certainty, avoid procyclical after-the-fact contributions, and introduce coverage that can be maintained without public support even in a crisis.

54. Extraordinary support should be withdrawn also in the structural area Short-term crisis policies in the labor market and state aid have helped to preserve employment in the recession, but they could impede long-run growth if continued well into the recovery. The government’s intention to change the conditions of the Kurzarbeit scheme in line with the recovery is as necessary as it is welcome in this regard.

55. Additional reforms can help Germany’s adjustment to the post-crisis world—and contribute to reducing global imbalances. Reduced potential growth and the threat of lower export growth raise the importance of further improving the flexibility of domestic markets. Lower legal and labor-court-based employment protection would facilitate reallocation of workers, while simultaneously improving product market competition and service sector development would foster labor demand. These reforms, through strengthening domestic sources of growth, would not only benefit Germany but could also help rebalancing euro area and global trade.

56. It is proposed that the next Article IV consultation be held on the standard 12-month cycle.

Table 1.

Germany: Selected Economic Indicators

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Sources: Deutsche Bundesbank; Federal Statistical Office; IMF staff estimates and projections.

IMF staff estimates and projections.

Growth contribution.

National accounts definition.

Eurostat definition.

Deflated by the national accounts deflator for private consumption.

The federal government’s budget balance in 2010 would improve by ½ percentage point of GDP if the support to the federal employment agency were not a grant but a loan.

Including supplementary trade items.

Data for 2010 refer to January.

Data for 2009 refer to the change to December

Data reflect Germany’s contribution to M3 of the euro area.

Data for 2009 refer to December.

Data for 2010 refer to January.

Based on relative normalized unit labor cost in manufacturing. Data for 2010 refer to January.

Table 2.

Germany: Foreign Claims of Banks on Individual Countries, December 31, 2009 1/

(In billions of U.S. dollars; unless otherwise specified)

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Sources: BIS; Deutsche Bundesbank; ECB; and IMF staff estimates.

Foreign claims include all international claims plus local claims of foreign affiliates in local currency. The difference between the claims to all countries and the sum of mature and emerging market exposures is due to offshore center exposures.

BIS data is based on the consolidated lending statistic compiled by the Bundesbank (as of 2009:Q2).

The data are derived from the “Groß- und Millionenkreditmeldung” stipulated in §§ 13 and 14 KWG (Credit Services Act). Under the Credit Services Act, debtors are obliged to register all loans (and other credit-like obligations) of €1.5 million or higher with the Bundesbank on a quarterly basis. In this context, the definition of credit also included equity and counterparty risk exposure from credit default swaps (CDS). Specific details on the obligation to register are stipulated in the Groß- und Millionenkreditverordnung (GroMikV). Credit derivative exposures are recorded as off-shore transactions at their nominal value if available, otherwise the book value applies. The presented data reflect gross amounts without recognition of collateral.

Table 3.

Germany: The Core Set of Financial Soundness Indicators for Banks, 1999-2008 1/

(In percent)

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Source: Deutsche Bundesbank. The authorities provide annual data only and disseminate them once a year.

A methodological break in the supervisory time series on the capital adequacy of German banks has taken place in 2007 due to substantial changes in the regulatory reporting framework, following Basel II.

1998-2006 according to Capital Adequacy Regulation, Principle I. Since 2007 according to Solvency Regulation.

2000-2008 data compiled in accordance with IMF’s FSI Compilation Guide. Data not available before July 1, 2000.

Due to one off data availability, comparability of 2006 data with other years limited.