Abstract
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 would like to thank the staff for a well written and balanced report and to express my authorities’ appreciation for focused and open discussions during the consultation.
My authorities broadly share the staff’s assessment of the current economic situation and the prospects of the German economy. Because of the strong links to the world economy, Germany was hit particularly hard by the global financial and economic crises. Germany’s gross domestic product fell by five percent in real terms in 2009, the sharpest drop since the founding of the Federal Republic. Both strong domestic policy support and recovering global demand have positively affected the German economy; a moderate recovery is underway. In January, the federal government revised its projection of real gross domestic product growth from 1.2 percent to 1.4 percent in 2010, slightly higher than the staff’s projection.
With the changing economic situation, policy demands are changing, too. To ensure that crisis-related state interventions and support measures do not throttle individual initiative and forces for innovation, the German authorities will focus on a consistent exit strategy. The right timing and design of exit strategies in fiscal policy, monetary policy and the financial sector is important for the sustainability of the recovery and will help build positive expectations in the markets. Most government measures to stabilize the financial system and to support companies and consumers will expire at the end of 2010. My authorities are also well aware of the importance of international cooperation and advocate an internationally coordinated strategy for an orderly exiting.
Economic situation
The comprehensive measures undertaken to support the financial system and the economy have made a marked contribution towards stabilizing the economic situation and securing the long-term perspectives for growth in Germany. In 2009 the stimulus measures (inter alia tax relief, car-scrapping program, stabilization of the labor market) were implemented at the right time, as exports declined very sharply. While both private consumption (+0.2 percent in real terms) and public consumption (+3.0 percent) have been stabilizing factors in 2009, in 2010 the stimulus focuses on investment which will lead to an increase in total domestic demand by 0.6 percent. Moreover, net real wages are expected to rise. My authorities are very confident that there will be no massive increase in unemployment as expected in the wake of the severe economic crisis.
Over the last years, the German labor market has become more dynamic, flexible, and adaptive, and has proven to be remarkably robust during the crisis. Increased firm-level flexibility to smooth working hours over the cycle, a stronger underlying employment trend, and the very effective government program subsidizing short-time work (Kurzarbeit) played an important role in containing job losses. However, as unit labor costs have increased substantially, the scope for keeping the high level of short-time work is limited. The aim of a currently ongoing debate is to find the right balance between the benefit of short-time work as a means to stabilize employment and income and the potential negative effects of hampering necessary structural labor market adjustments.
My authorities agree with staff that the financial and economic crisis will have a negative impact on potential output growth in the medium term. For the time being, potential output may only increase at a moderate pace and the current under-utilization of industrial capacity will probably ease only gradually over time. However, looking ahead, the recuperation process will be supported by structural reforms. Alongside the immediate measures that have been taken to boost the economy, implementing structural reforms in order to expand opportunities for longer-term growth and to strengthen domestic sources of growth is a priority for my authorities.
Fiscal policy
Germany’s fiscal policy strategy is fully in line with IMF recommendations. Fiscal support will be maintained in 2010 as the German economy has not reached a self-supporting and stable growth path yet. The government will implement the fiscal stimulus measures as planned and as announced internationally. Moreover, my authorities have adopted further measures which amount to an additional stimulus of around €6 billion or ¼ percent of GDP in 2010 with the “Economic Growth Acceleration Act” (Wachstumsbeschleunigungsgesetz) which entered into force January 1st, 2010. Thereby, Germany set additional incentives for investments and lowered the fiscal burden of families.
Despite the crisis and the necessary fiscal stimulus measures, the overall deficit could be contained to 3.3 percent of GDP in 2009; only marginally above the requirement of the European Stability and Growth Pact. For 2010, my authorities project an overall deficit of around 5.5 percent of GDP. The cost of the automatic stabilizers, the discretionary fiscal stimulus measures, measures taken to stabilize the financial system, and by no small means the decline in GDP led to a substantial increase in the ratio of general government debt to GDP to 73 percent in 2009. The debt to GDP ratio is expected to increase further to 77 percent in 2010 and to reach around 82 percent by 2013.
From 2011 onwards, the focus will be on fiscal consolidation, as called for under the European Stability and Growth Pact as well as the new national constitutional rule (Schuldenbremse) to limit the government deficit. My authorities continue to pursue their medium-term goal of a close-to-balance government budget in structural terms.
Given my authorities’ ambitious approach with regard to expenditure cuts, sound public finances can most likely be reached without further revenue measures. Nevertheless, should the next tax forecast show a need for revenue measures, tax broadening would be preferable to higher tax rates. My authorities do not intend to increase VAT rates. Furthermore, they are of the view that the relatively low unemployment contribution rate has considerably contributed to mitigating the effects of the current economic crisis on the German labor market. Therefore, no further increases in the contribution rate are under consideration at present, apart from the raise of the contribution rate from 2.8 percent to 3 percent already scheduled for January 1st, 2011.
Independent of the consolidation efforts, my authorities see a strong need for growth enhancing tax policies contributing to an increasing motivation of consumers, enterprises, and investors. My authorities plan to implement a simpler tax system with lower tax rates and measures to reduce bureaucracy. Providing relief, particularly to lower and middle income groups, will support consumption and create incentives to work. The new tax structure is supposed to enter into force on January 1st, 2011, taking into account both economic developments including their effects on the perspectives for the public budgets, and structural savings. This is to create the necessary leeway in line with the budget rules set out under European and constitutional legislation.
Spillovers
My authorities share the staff’s view that fiscal policy in Germany has a role model function for other EU countries. Therefore, as stated earlier, my authorities are determined to adhere to the requirements of the Stability and Growth Pact and to the recommendations of the ECOFIN Council to correct the excessive deficit in order to set an example for much needed fiscal consolidation in Europe.
Overall, Germany played a significant role in stabilizing the world economy in 2009. While German exports plummeted in 2009, imports dropped less and contributed to narrowing Germany’s current account surplus. According to preliminary calculations, in 2009 the German current account surplus decreased by nearly €48 billion or about 2 percent of GDP compared to 2008. Furthermore, it is noteworthy that the German current account surplus is not the result of policy measures explicitly aimed at promoting export performance but rather the result of a multitude of private business decisions. Germany’s strong export orientation stems from the openness of its economy, its long-standing manufacturing traditions and its competitiveness in global markets.
Nevertheless, my authorities recognize that higher domestic demand would not only contribute to reduce the current account surplus but would be beneficial for Germany. However, means to promote domestic demand are rather limited. Wages are not a macroeconomic policy tool in Germany, and income tax cuts beyond the proposed measures would have a detrimental effect on fiscal consolidation. Having said that, my authorities support the conclusions of the Eurogroup of March 15th, 2010, regarding intra Euro area competitiveness and macroeconomic imbalances. As called for in the conclusions, my authorities stand ready to identify and implement structural reforms that help strengthening domestic demand.
Financial Sector
Stability in the financial sector has significantly improved during the last year and systemic risks continue to subside as economic fundamentals recover. Measures as the establishment of the Sonderfonds Finanzmarktstabilisierung (SoFFin) providing guarantees and funding for recapitalization of financial institutions have contributed substantially to the stabilization of the financial sector. However, there are still pressing challenges from the crisis and reasons to remain cautious. Financial institutions faced and are still facing massive write-downs. For securitizations, however, the vast majority of potential losses has already been accounted for. With regard to potential adverse repercussion due to continuing stress in the real economy and the financial sector, Germany benefits from comparatively moderate indebtedness of both corporations and households as well as from price stability in the real estate sector.
For the time being a credit crunch cannot be observed. However, with increasing numbers of insolvencies in the real economy and rising unemployment rates, further pressure on banks’ balance sheets could lead to potentially negative consequences for lending. Thus, since March 2010, businesses facing lending problems are able to turn to a government-appointed credit mediator who will take action to ensure that creditworthy companies – particularly small and medium-sized firms – are able to obtain loans. Furthermore, the credit guarantee program of the “Business Fund Germany” (Wirtschaftsfonds Deutschland) established in March 2009 is an option for companies to secure access to credit.
The ongoing restructuring process of the Landesbanken is a necessary step and contributes to stability in this sector. After several Landesbanken received financial aid from states (Länder) and the SoFFin during the current financial crisis, they will have to downsize and/or change their business model as required by state aid rules of the European Union aiming at preventing distortions of competition due to government interventions. Länder governments are committed to this reform process.
Regulatory and supervisory reforms of the financial sector remain a key priority for my authorities. Ongoing work in that area is done in cooperation with regional and international partners with the target to emerge from the current crisis with an enhanced and strengthened framework ensuring that all financial institutions, instruments and markets are subject to adequate regulation and oversight.
The reform of financial supervision envisages a consolidated banking supervision in the Bundesbank. My authorities agree with staff that, as under the current regime, the supervisory body has to be both accountable and operationally independent. Detailed reform proposals taking into account existing synergies of an integrated financial supervision and the independency of the Bundesbank will be presented in the summer. The new supervision structure is scheduled to become effective in spring 2011.
My authorities intend to develop a legal framework for an effective bank resolution regime which allows for timely action to prevent systemic contagion. The key objectives of this resolution regime will be to enable early interventions as well as a managed resolution and an orderly wind-down of systemically-important banks. Such a framework can impose market discipline and, by providing a mechanism to ensure appropriate financial contribution of the private sector, protect public funds. This new national framework corresponds with conclusions on the G20 level and complements recent initiatives by the European Commission, i.e., the advised proposal for a European Framework for Cross-Border Crisis Management in the Banking Sector.
The deposit insurance system is a pillar of financial stability in Germany and has proven its quality during the financial crisis. Despite several ailing banks, none of the depositors has lost any of its protected deposits during the financial crisis, neither in the sector of the private banks nor in the sectors of Sparkassen and mutual banks (Kreditgenossenschaften). In the latter sectors, where the system does not only protect deposits but also prevents insolvency of banks, no bank has become insolvent in the last five decades. Since the establishment of the private banking sector, no depositor suffered any loss of protected deposits in the case of an insolvency of a private bank that was a member of the German deposit insurance system. In the current crisis, the SoFFin supported only the voluntary scheme of the association of private banks, not any of the mandatory ones. Nevertheless, Germany is developing its system and is actively taking part in the current discussions at EU level to make depositor protection even more efficient.