2011 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Germany

Germany’s economic growth and recovery from the global crisis are explained in this study. Tax, education, and innovation policies are specific measures supported by the authorities. External and financial shocks received by Germany and other outward spillovers are outlined. Germany has a high current account and international assets. From a long-term perspective, rebalancing of public finances to promote growth is desirable. Stress tests are conducted to confirm the capital buffers. Finally, the banking system of Germany reflects significant policy measures and economic recovery.


Germany’s economic growth and recovery from the global crisis are explained in this study. Tax, education, and innovation policies are specific measures supported by the authorities. External and financial shocks received by Germany and other outward spillovers are outlined. Germany has a high current account and international assets. From a long-term perspective, rebalancing of public finances to promote growth is desirable. Stress tests are conducted to confirm the capital buffers. Finally, the banking system of Germany reflects significant policy measures and economic recovery.

I. Outlook

1. The recovery has brought German output and employment above pre-crisis levels. After the world economy’s fearsome drop starting in the second quarter of 2008, economic activity in several emerging markets is now above pre-crisis levels while advanced economies are just approaching those levels. In the first quarter of 2011 German GDP surpassed its pre-crisis level following growth of 3½ percent in 2010, and employment is higher than before the crisis. On both these counts only a few advanced economies have done as well. The United States is somewhat ahead in terms of output but significantly lags in employment growth. Consequently, the United States has gained in terms of productivity growth, a reminder that Germany has considerable ground to make up on productivity.


World trade was near precrisis levels in December 2010.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


The German economy was near precrisis levels in December 2010.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


While US output has picked up slightly faster…

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


…US employment has lagged.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

2. The nature of the German recovery and its growth prospects are explained by the prominent role of external demand. More so than elsewhere by far, Germany’s crisis contraction and the recovery were driven by external demand. Thus firms, viewing the downturn as temporary, had greater incentives than elsewhere to retain workers—and the hourly flexibility in labor contracts and the short-work subsidy scheme (Kurzarbeit) were well suited to reinforce those incentives. Also, because the demand shock predominated, potential growth did not fall significantly and the output gap is projected to close later this year (Box 1).


The German crisis and recovery were externally driven, more so than in most other countries.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

Note: The bars represent cumulative contributions to growth from domestic and external sources during 2008Q2-2009Q1 and 2009Q1-2010Q3.

A. A Gradual Growth Slowdown

3. Growth will remain above potential in the short term, but the economy is expected to slow gradually. Staff’s estimate of a small output gap is supported by continued buoyancy of production, confidence, and orders data; the expected improvements in employment reflect convergence to a lower structural unemployment rate (Box 2). Staff projects the economy to expand by a still healthy 3 percent in 2011, in line with the authorities’ assessment. This will cause the output gap to close towards the end of the year. Growth will continue to slow as the fiscal consolidation takes hold, the output gap closes, and world trade growth slows after its bounce back. The authorities noted that domestic demand may grow stronger than projected by staff, pointing to the expected increase in the wage bill as well as a pickup in investment activity. Staff viewed such rebalancing as a cyclical response triggered by the export impetus and, thus, not yet a reflection of a structural shift.


Germany: Growth Contribution of Domestic Fiscal Measures and Spillover From Fiscal Policy in Other Countries, 2010-2012

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

Germany’s Growth Potential—Little Damaged but Low

The impact of the crisis on German potential GDP was relatively mild. Germany experienced a temporary decline in external demand, in contrast to longer-lasting, structural shocks elsewhere. Staff estimates that German potential growth during the crisis has declined only moderately from its pre-crisis rate of about 1¼ percent. As such, German potential GDP will likely suffer limited permanent damage from the crisis in contrast to more persistent losses elsewhere—U.S. potential GDP, for example, is projected to be about 5 percent below its pre-crisis trend in 2015.


Negative output gaps are more persistent in other advanced economies.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


Unlike the U.S., German potential GDP has suffered no permanent loss…

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ Pre-crisis trend extrapolated based on staff estimates of historical potential growth of 1¼ and 2½ percent for Germany and the U.S., respectively.

…but Germany’s long-term potential growth rate remains low.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

The benign crisis impact does not resolve Germany’s long-term problem of low potential growth. While Germany escaped the crisis with little permanent damage, its long-term growth prospects, estimated by staff at about 1¼ percent annually, remain low. This view was shared by the authorities who see potential output growth at between 1¼ and 1½ percent. Thus, although the U.S. has lost ground relative to its pre-crisis trajectory, the growth gap vis-à-vis the U.S. will remain significant.

Labor Market Dynamics During the Crisis and Beyond

German employment remained remarkably stable during the crisis. The outcome reflects the nature of the shock experienced, the institutional framework, and supporting policies.

  • While the shock was severe, firms perceived it as temporary and so had the incentive to hold on to labor and reduce hours worked rather than lay off workers.

  • It helped that in recent years, flexible workweeks and work-time accounts had been incorporated into collective agreements. The subsidy for reduced work-time hours (Kurzarbeit) was extended and similarly reinforced the incentives to adjust employment through hours.

  • The Hartz reforms in the early 2000s redesigned unemployment and welfare benefits, and thereby increased the flow into employment, especially at the low-wage end. This has led to a decline in the steady-state unemployment rate, which is projected to reach about 6¼ percent or less, from over 8 percent historically. This underlying downward trend also explains the moderate unemployment response.


The unemployment rate has trended downward…

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


…consistent with a lower steady-state unemployment rate.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

Note: Simulations are based on a simple search-based labor model with different assumptions on the effect of the Hartz reforms on the unemployment outflow rate.

4. Germany has had a creditless recovery. This is not a surprise. In recent years, bank credit and indicators of economic activity have been only loosely correlated. Even so, the anemic credit growth in the past year to households and especially to enterprises is remarkable considering the strength of the Germany recovery and also the pace of credit growth elsewhere in Europe. With little substitution to other forms of external financing, German corporates have apparently relied on their own profits to finance the recovery. For a sustained rise in investment rates and rebalancing, stronger credit growth will be important. The authorities noted that in the past, credit has picked up with a lag and they expect that further GDP growth will be supported by the extension of more credit.


The liabilities of the corporate sector are still below pre-crisis levels, with very limited substitution between financing sources occurring.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


Germany has had a creditless recovery.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ Based on notional stock growth rate provided by the ECB, as credit outstanding values are biased by changes in accounting methodology.

B. Raising Medium-Term Growth

5. The low potential growth rate reflects a combination of factors. GDP growth is projected to converge, by 2015, to the long-term potential rate of 1¼ percent. Over the last decade, labor and capital services have made modest contributions; adjusted by hours worked, the contribution of labor has been nil. Total factor productivity (TFP) has responded to cyclical factors, falling sharply in the crisis and then realizing an offsetting gain in the recovery. But the recent flattening is consistent with low long-term average TFP growth. Productivity growth has been strong in Germany’s traditional areas of strength, rising but below that of the U.S. in the production of information and communications technology products, and low in services, especially business and trade services.

Decomposing Growth

(qoq, Annualized)

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The German population is declining and aging.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

Contributions of Sectors to Average Annual Labor Productivity Growth in Market Services, 2000-07

(in percentage points)

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Source: EU KLEMS database, November 2009 release, and IMF staff estimates.Notes: Numbers may not add up due to rounding.

In 2007.

Impact of changes in the distribution of labor input between industries on labor productivity growth in market services.

Figure 1.
Figure 1.

Germany: Productivity Trends in the Private Economy, 1985-2007

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

Source: EU KLEMS database and IMF staff estimates.

6. Export dependence offers some upside growth potential but the downside risks argue for strengthening domestic demand. Growth in its main trading partners has been a major determinant of German export performance. A one percentage point increase in growth in its main trading partners can lift German growth by up to ½ percent. Arguably, the strong growth prospects in emerging markets offers Germany continued opportunities. However, this dependence also represents a downside risk, and, in particular, will require maintaining its export market shares in the face of growing sophistication of the emerging market producers themselves. Also, the volatile nature of export-dependent growth underscores the necessity to strengthen domestic sources of demand. This view is shared by the authorities in their contribution to the Group of Twenty (G-20) mutual assessment program.


Growth in trading partner countries is a major determinant of German export performance

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

7. A multi-pronged growth agenda is required. All three contributors to potential growth, labor, capital, and productivity need attention. First, merely to offset the sharp decline in the working-age population over the next decade would require an about 2½ percentage point increase in labor force participation, a gap unlikely to be filled by additional immigration. Second, the low investment rate needs to be raised. And, finally, higher productivity growth will benefit from investment and innovation, especially in areas outside Germany’s traditional strengths. Productivity gaps in the services sector require greater usage of information and communication technology (ICT), where Germany can close the gap with the international frontier. The importance and crosscutting nature of ICT is reflected in Germany’s High Tech Strategy, and, more broadly, in Europe’s 2020 growth agenda, which also notes the link between ICT usage and services’ productivity.


The share of investment and research in information technologies is relatively small in Germany.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


The private services sector in Germany has invested relatively less in information technologies.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


Public procurement of hi-tech products is low by advanced-country standards.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


High risk financing is less available than in other OECD countries.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

8. This agenda needs to be supported by specific policy measures. Based on discussions with the authorities, the measures with the greatest expected leverage to support these objectives are:

  • Tax policy. Tax policy to increase incentives for labor participation and investment is discussed in section IV on public finances.

  • Education policy. While the authorities noted that important education initiatives are already bearing fruit, they recognized the need for more widespread early childhood care and education, reorienting vocational training to emphasize lifelong learning, and further upwards mobility within the education system.

  • Innovation policy. Promoting the availability of risk capital will help raise incentives to invest in higher-risk, higher-growth sectors. In this regard, removing uncertainties regarding tax treatment, redesigning change-of-ownership rule, which eliminates loss and interest carry-forward, as well as improving the efficiency of the insolvency process (by promoting faster restructuring proceedings, including through legislative initiatives currently underway) would help develop further venture capital and private equity markets. Further efforts in increasing commercial use of intellectual property rights held by universities and research institutions should be considered.

C. Modest Inflationary Trends

9. Rising commodity prices will temporarily lift German headline inflation in 2011. Staff and authorities project headline inflation to increase from 1.2 percent in 2010 to 2½ percent in 2011, due largely to energy and food price pressures. With these pressures currently seen as temporary, and inflation expectations already scaling back, headline inflation is projected to drop to about 1½ percent in 2012, and then converge back to an annual rate of about 2 percent in the medium term.


After rising since August 2010, inflation expectations are moderating.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ Difference between yields on five-year Bunds and inflation-indexed debt.

10. Core inflation is projected to rise only moderately. For 2011, staff projects core inflation to rise to 1¼ and to about 2 percent in 2012, up from 0.8 percent in 2010. A part of this rise, however, is influenced by prices of imported raw materials, and will subside as the rate of increase of imported prices falls. While a declining output gap will pull up core inflation, slack in most sectors suggest that this increase will remain moderate in 2011. Negotiated wage agreements have been moderate thus far, consistent with a continued decline in the structural unemployment rate. With German inflation slightly below the euro area average but the output gap closing somewhat faster, euro area monetary policy has been broadly appropriate for Germany.


European monetary policy after the crisis has not been out of line with optimal interest rate predictions for Germany.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

Notes: Confidence interval of optimal interest rate predictions for Germany based on five Taylor-rule specifications. See Berger-Quint (2011) for details.

Energy and food pressures lift headline, but core inflation remains moderate.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


Capacity utilization is near the historical average but much below peak.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


A negative overall output gap will keep inflation moderate.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ Based on a multivariate maximum-likelihood estimation.

Sectoral output gaps remain negative or close to balance.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ Measured as deviations from a linear time trend.

II. Spillovers

11. Germany has been a sensitive recipient of external real and financial shocks. These external shocks have accounted for almost half of business cycle fluctuations in Germany, the highest among the G-20 countries. Recent market data reinforces the conventional analysis of the role of external shocks, showing that the large movements of German stock and bond prices have been driven mainly by developments outside Germany.


Sensitivity to external shocks is the highest among the G-20.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


Large equity price movements were driven by US and Japanese developments, whereas the euro crisis has been more influential on German bond yields.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

Note: “Large movements” are the 20 most substantial changes during the last 15 months.

12. Despite its large economic size, Germany has not been a significant independent source of global growth. Germany’s outward growth spillovers have been small compared to other large countries. The limited outward spillovers from Germany and large inward spillovers are related. Countries with high sensitivity to external shocks generate limited outward spillovers. Germany transmits impulses from the United States and Asia, mainly to European economies with strong trade links. The authorities suggested that Germany’s robust recovery could enhance its role as an independent engine of growth. They also noted that those countries that are thought of as locomotives experienced unsustainable residential investment booms and rising current account deficits. And they pointed to beneficial effects from German foreign direct investment on growth in Central and Eastern European countries which have been integrated into Germany’s regional supply chain.


Germany’s outward growth spillovers have been small compared to other large systemic countries.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


The lack of autonomous sources of domestic demand results in small spillovers.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ GDP-weighted average response of other countries.2/ Excluding Germany.

13. Thus, German fiscal policy also has limited consequence for European growth. Fiscal actions convey across borders through trade, which dilutes the growth impact even where strong trade links exist. With multipliers in a generally-accepted range, the external growth effects of German fiscal policy are small. In particular, for the most stressed economies in the European periphery, high fiscal multipliers would need to operate for relatively modest effects. Similarly, fiscal policy changes in Germany have only a small impact on the trade balance of peripheral countries, and are thus unlikely to contribute to the reduction in intra-European imbalances. The authorities agreed with this analysis, and pointed to the low import content of public consumption. Moreover, they argued that German fiscal consolidation could benefit the periphery by lowering interest rates, which would help especially with risk premia so high.


The import content of public consumption is low.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


Growth spillovers from Germany to Greece, Ireland, and Portugal are small.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ GDP-weighted average response of Greece, Ireland, and Portugal.

Fiscal spillovers from Germany to Greece, Ireland, and Portugal are small even assuming large fiscal multipliers

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ Government spending shock is 1 percent of GDP increase in spending. The simulation assumes large domestic fiscal multipliers on government spending averaging at 1.6 for Germany, USA and France.

14. Greater contribution to European and global rebalancing would require more autonomous German sources of domestic demand. Stepped up efforts to raise potential growth would contribute to that goal if they create wider employment opportunities alongside higher productivity growth, particularly in the non-tradables sector. In addition to creating incentives for greater domestic investment, higher permanent incomes would also sustain higher consumption growth. While the authorities shared this perspective, they also felt that some of the rebalancing was already occurring.

15. The German financial system could generate outward spillovers—and it is susceptible to shocks from other large financial systems. The large size of Germany’s financial system, its international connections, and the nonlinear behavior of these connections at times of stress, imply that Germany could have a larger cross-border influence through its financial system than through its real economy. For this reason, as the authorities recognize, a robust financial system is important for both German and global financial stability. The risks of financial spillovers into Germany arise mainly from other large financial systems. Broader risks arise from the continuing uncertainty with regard to the debt obligations of euro area sovereigns and banks under stress, which creates an environment where contagion risks are elevated. Staff proposed that these challenges warrant a more comprehensive and consistent European policy response, and the German authorities emphasized the need for a clear framework that paid due regard to moral hazard and private sector involvement.

16. German exposure to direct risk from the European periphery is limited in terms of banks’ assets but more wideranging implications are possible. Aggregate exposure of German banks to sovereign and bank debt held in peripheral economies is small relative to the size of their assets. But this exposure represents about 30 percent of total bank equity. Moreover, the exposure is concentrated in select banks, which, if placed under stress, could have more widespread knock-on effects. Similarly, stress from the periphery to banks outside Germany could also create stress in Germany. Thus far, these risks have not been viewed as significant by the market: to the contrary, the German sovereign has been a safe haven when the periphery has been under financial stress—in such conditions German bond yields have declined or remained constant.

Exposure of German Banks to Banks and Governments on Ultimate Risk Basis as of September 30, 2010

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Exposures to the periphery are small relative to the size of the domestic system

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ Exposures on ultimate risk basis cover 100 percent of borrowers for Ireland, Greece, and Portugal and about 90 percent of borrowers for Spain, and Italy (borrowers with an indebtedness above 100 mln. euro)

Large increases in peripheral sovereign yields are accompanied by small movements in German yields.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

Source: Thomson Financial/Datastream.

III. External Accounts and Competitiveness

A. Current Account Balance

17. Riding the wave of global growth in the run-up to the crisis, Germany, amongst others, experienced a large increase in its current account balance. Germany’s current account surplus rose to about 7½ percent of GDP just before the Great Recession. In addition to long-term forces generating precautionary savings in Germany, the peak surplus also reflected a cyclical rise in exports during the boom years (Box 3). In those years, high surpluses also rose in China and Japan, mirroring the rise in the U.S. deficit. The German surplus has since receded to about 5 percent of GDP.


Current account imbalances widened rapidly before the crisis and remain large

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

Structural Factors and the Current Account

The emergence of global imbalances cannot be explained by current account models. In the long term, current account balances are to a large extent driven by fundamentals such as per capita income level, fiscal policies, demographic factors, oil prices and the initial net foreign assets position. The traditional drivers of the current account, however, cannot explain the recent surge in global imbalances. The residuals from the current account equation largely mirror the imbalances from 2000–09.

Structural factors also cannot explain the emergence of the imbalances, although they may explain the level of a country’s balance. The impact of structural factors on the current account is not robust across country samples, with some commonly recommended reforms increasing and some reducing the current account balance. The econometric results suggest, though, that Germany could reduce its surplus through lower taxes on business and labor, further reduction in the gross unemployment replacement rate, and a smaller public share of the banking system.


Traditional drivers of the current account cannot explain the recent surge in global imbalances

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

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Regulation in the credit market is measured by the index, which includes four components (i) ownership of banks measured by the percentage of deposits held in privately owned banks, (ii) control of interest rates, (iii) percentage of credit extended to private sector and (iv) competition from foreign banks. Germany scores low on this indicator due to the high degree of public ownership in the banking system.

18. Germany’s current account surplus reflects a positive trade balance especially vis-à-vis other European countries. Trade surpluses for goods have been the main driver of Germany’s current account; in fact, Germany has not recorded a trade deficit in goods in the past 50 years. Estimates based on CGER-like methodologies show that Germany enjoys a moderate competitive advantage between 2 and 9 percent. In recent years, the surplus with other European countries has risen, raising the concern with regard to “intra-European” imbalances. The trade balance with China, on the other hand, has been negative and has widened in the last decade. These developments, the authorities agreed, are related.

Exchange rate assessment based on CGER-like methodologies

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Note: Deviation from equilibrium exchange rate in percent, a negative sign represents undervaluation

Germany’s current account has traditionally been driven by trade in goods…

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


…and Europe dominates the trade balance.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

19. Germany’s export competitiveness derives from a comparative advantage in a large number of specialized product varieties. German firms have specialized in a large variety of capital goods, consumer durables, and pharmaceuticals and they enjoy significant world market shares in these products. The authorities noted that by the onset of the pre-crisis boom, the decline in competitiveness following unification had been counteracted. Germany was able to hold market share, allowing exports to ride the global trade wave. There is, however, a cautionary tale here. The U.S. also enjoys specialization in a large number of products, but has been losing market share in the past decade. Thus, global competition, especially from emerging nations, will likely challenge traditional German dominance.


Germany’s competitive advantage arises from specialized product varieties.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

Note: Computed with SITC 4 level trade data for 2007.

Germany’s export growth is mainly due to growth in world trade, not increasing market share.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

Note: Increase in exports 2001-08, as percent of exports in 2001, decomposed into the effect of world trade growth and that of increased market share. Computed with SITC 4 level trade data.

20. The growth in intra-European imbalances, therefore, reflects continued German competitiveness alongside the rise of non-European, especially Chinese, competition. With increased exports to the rest of Europe, Germany maintained its traditional supply chains, resulting in larger European imports, especially of intermediate goods from Visegrad countries (Czech Republic, Hungary, Poland, and Slovakia). However, the increased trade imbalance within Europe reflects the tilt in Germany’s import towards products produced most cost-effectively by China. Thus, while German exports have remained largely insulated from Asian and lower-wage European competition, much of advanced Europe—including the periphery—faced the new reality of global low-wage competition. Consequently, the authorities felt that the periphery’s weak competitiveness will require solutions in the periphery.


The import share from China has grown rapidly

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

Note: Visegrad countries include Czech Republic, Hungary, Poland, and Slovakia

21. In popular discourse, raising German wages to reduce German competitiveness is often recommended, as is reducing the household savings rate.1 But these approaches are neither analytically nor pragmatically sound.

  • Despite recent wage moderation, German wages are amongst the highest in Europe (changes in nominal wages and unit labor costs are highly correlated). Since its competitiveness derives from product specialization, raising German wages would do little to improve export prospects of countries that do not compete with Germany in its specialized products. Higher wages would increase domestic consumption only if seen as sustainable by residents but would hurt if, as the authorities suggest, they reduce investment incentives further.

  • The German national saving rate is about on par with advanced European peers. Household saving rates are also not exceptionally high. Reducing domestic savings rates will require bucking a long-standing tendency in Germany for precautionary savings; moreover, providing greater social security to reduce the incentive to save would go against public finance considerations; and finally, addressing Germany’s traditionally high level of precautionary savings is best seen as the end result of raising domestic sources of growth, rather than the starting point.


Despite recent wage moderation, Germany’s wages are among the highest in Europe

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


Germany’s saving rate is around the OECD average…

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


…but its investment is low.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

22. The most sustainable approach to reducing the German current account surplus is likely through policy efforts to raise domestic investment rates, which are low among advanced economies. The corporate sector was the main contributor to the increased surplus during the boom years. The rise in corporate savings, reflecting increased profits and low dividend payout, was not matched, as the authorities recognize, by a compensating increase in domestic investment. Indeed, corporate investment remained low compared to European peers even accounting for foreign direct investment (FDI) outflows. This should be a matter of some concern: corporations were unwilling to invest when the resources and the opportunities seemed ample. The reluctance to invest domestically reflects long-standing low returns to investment in Germany. The key to raising investment is likely to be a restructuring of public finance priorities (as discussed below). But, in addition, the broader growth agenda would increase permanent incomes, reduce uncertainty and, hence, stimulate consumption and investment, further contributing to reduced surpluses. Although the authorities expect investment to pick up given the recent recovery in capacity utilization, they see merit in improving the investment climate. They also recognize that reducing banks’ incentives to seek higher yields abroad and more proactively develop domestic business would be a help.


German Investment Has Been Low Compared to EU Peers Even After Accounting for Outward FDI

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


The increase in the current account surplus was largely due to a decline in investment,

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


as both household and corporate investment has fallen over time

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

B. International Investment Position

23. Germany has exported capital to match its surpluses, increasing sharply its holding of international assets. Outward foreign direct investment has increased to above 40 percent of GDP. While the authorities rightly emphasized the value of German FDI to the receiving economies, they also recognized that financial investments by banks—through loans and the purchase of stocks and bonds—were the primary drivers of the large outflows prior to the crisis. Since 2007 banks have reduced their holdings of foreign assets, which have been partly transferred to the public sector through the resolution agencies.


Banks have driven the accumulation of foreign assets

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

24. Public banks contributed significantly to the accumulation of foreign assets. Landesbanken rapidly increased their foreign investments in the run-up to the crisis, even as private commercial banks stabilized and then decreased their foreign exposure. While the Landesbanken used wholesale funding sources to finance their international investment, they also drew on the Sparkassen, whose share of deposits placed in the Landesbanken increased considerably. The decision by Germany’s public banks to invest abroad in search of higher returns reflected the weak domestic demand for investment environment and their misplaced incentives to search internationally for yields, encouraged by the lack of a viable business model and a weak governance structure.


Landesbanken strongly increased foreign investment prior to the crisis

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

25. Germany’s foreign assets are primarily invested in Europe. At the end of 2009, Germany’s foreign assets were highly concentrated in the other Euro countries, for a gross exposure of almost 120 percent of GDP. The foreign asset position vis-à-vis Greece, Ireland, and Portugal was also significant, around 15 percent of GDP.


Most net foreign assets are accumulated in Europe

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

26. However, Germany finances a relatively small share of the international liabilities of Greece, Ireland, and Portugal. While, at the end of 2008, over 60 percent of the international liabilities of Greece, Ireland, and Portugal were financed within the European Union, Germany accounted only for a moderate share of 12 percent. Of the German banking sector’s exposure to these countries, public banks account for 31 percent.


Germany is not the sole financing source for Greece, Ireland, and Portugal

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

27. The returns to Germany on its foreign assets have been relatively low. Returns on foreign investment have been moderate and considerably below those realized by the United States. From 1986 to 2009, Germany earned an average 3 percent real return on its foreign assets. This is approximately half the return on U.S. foreign assets whose good performance can be partly attributed to the US dollar depreciation. Germany’s return performance has only slightly improved since 1996.


Return on foreign assets is at par with Japan, but well below the United States

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

IV. Public Finances

28. From a sizeable stimulus, the authorities are moving towards a gradual consolidation. The German fiscal stimulus during the crisis phase was comparable to—or larger than—in other advanced economies. That stimulus is now set to be phased out and a consolidation process has begun. The package is ambitious by historical standards (Box 4). Staff estimates suggest that the size of the consolidation (at about ¾ percentage points of GDP per year) is likely to be larger than that implied by the authorities’ estimates of the structural balance based on the output gap. The latter incorporates a larger allowance for the reduction in cyclically-adjusted spending than occurred on account of the strength of the labor market in the downturn. The European Stability and Growth Pact (SGP) target can be achieved in 2011, and the objectives of the national fiscal rule and the preventive arm of the SGP are within reach at the latest by 2016. The increased primary surplus will help bring down the debt-to-GDP ratio from its current level of over 83 percent of GDP (having been boosted recently by banking sector support).


Germany fiscal stimulus was one of the largest among advanced countries.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


Germany has now embarked on an ambitious consolidation.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ Using structural balance computed based on changes in the output gap for Germany.2/ Using structural balance computed based on labor market developments for Germany.

The consolidation will improve the primary balance, albeight not to pre-crisis levels, …

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ Under the no policy change scenario primary balance remains unchanged from 2011 onwards while all other macroeconomic variables are the same as in the baseline. Under the historical average scenario all variables, including primary balance, growth and interest rate, are at historical averages.

…and it will reduce debt.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ Growth shock assumes real GDP growth at baseline minus one-half standard deviation. Real interest rate shock assumes baseline interest rate plus one standard deviation. Contingent liability shock assumes a 10 percent of GDP increase in other debt-creating flows in 2012.

Large Fiscal Adjustments are Subject to Risks1

Fiscal consolidation has been a key concern for German policy makers. With the debt-to-GDP ratio on a generally rising trend, periodic efforts have been made to rein it in. Four large fiscal adjustment initiatives were in 1976–79, 1982–85, 1992–95 and 2004–07.


The debt to GDP ratio has been rising

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

The lesson is that fiscal consolidation is subject to considerable risks and political commitment is a key to the success. Weakened macroeconomic conditions may override consolidation objectives (as in the 1970s) and unexpected impediments may arise (as after the unification during the 1990s). A political commitment to continue with the consolidation despite unfavorable circumstances was made in the 1980s. Even greater success was achieved in the 2000s when fiscal consolidation was combined with structural measures, including labor market and pension reforms alongside a reduction in the tax burden.


Consolidation is fraught with risks.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1Based on Breuer, Christian, Jan Gottschalk, and Anna Ivanova: “Germany: Lessons from Past Experience” in Chipping Away at Public Debt: Sources of Failure and Keys to Success in Fiscal Adjustment, ed. by Paulo Mauro (forthcoming).

29. Staff views the proposed consolidation path as appropriate. The German economy is on a path to close its output gap. From the European perspective, a slower pace of German consolidation will provide limited fiscal spillovers to the periphery, and elsewhere the need is less with output gaps also closing. At the same time, German debt at over 83 percent of GDP remains high, the demographic fiscal challenge lies ahead, and debt dynamics are susceptible to growth shocks and fiscal slippages. Adherence to Germany’s near-structural balance rule will strengthen the credibility of that commitment. The authorities recognize that some of their proposed measures (e.g., military spending cuts), however, remain under discussion. In case the savings envisioned do not materialize, the authorities recognize that additional efforts would be required elsewhere. They also emphasized that cyclical revenue gains would not be used to finance structural measures. Staff agreed but recommended the pace of consolidation be slowed in case of a substantial negative shock to growth.

30. From a longer-term perspective, and staying within the consolidation path, a rebalancing of public finances to promote growth is desirable. The need to increase labor participation is evident on account of the projected decline in the workforce and the scope for doing so is validated by the Scandinavian experience. Low-skilled, female, and elderly labor force participation is low compared to Scandinavian countries, which, like Germany, also provide extensive social benefits. The German labor tax wedge is particularly high for low-income earners. The 2008 corporate income tax reform improved Germany’s tax competitiveness. However, municipalities continue to rely on an inefficient and volatile trade tax with differential rates creating regional competition. The tax system also continues to favor debt over equity in corporate financing and tax constraints hinder the development of high-growth high-risk ventures. Together, these act to reduce labor and capital inputs, and hence potential growth.


Labor force participation could be increased

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/The ratio for low eduction level (both men and women) was computed using total female and male popuation since the data on population by eduction level is not available.

German marginal labor tax wedges, expeciallly at low and average incomes, remain high.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ This chart reports tax wedge for a single person without dependent, at various multiples (67%, 100%, 133%, 167%) of the average wage. The results take into account basic/standard income tax allowances and tax credits and include family cash transfers (see Taxing Wages). The tax wedge is expressed as a percentage of gross labour costs (gross wages + employer SSC).

High tax burden on labor accross all family types discourages labor participation

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

AW = Average Wage

High corporate income tax rates discouraged investment in Germany and elsewhere

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


High labor tax wedge has also contributed to lower domestic investment

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ Incremental investment reflects investment net of the effect of income and past growth and adjusted for trend. It is calculated as a residual from a regression of investment to GDP ratio on the lag of income per capita, lag of GDP growth and a time trend using a random effects model.

31. Reducing labor taxes along the participation margins could be most effective (Box 5). Marginal tax rate relief is best targeted at the participation margin of labor supply, and tagged to paid work. This can be implemented through the introduction of in-work credit programs for the elderly and secondary earners and an earned income tax credit for the low-income, with the possibility of a negative income tax. An alternative to the latter could be to raise the threshold for the low-income tax relief (the so-called mini-jobs) and reduce the speed at which tax benefits are withdrawn. Also, reforming the regime of income splitting for tax purposes could create better incentives for labor market participation as it would shift the marginal tax burden away from the more flexible partners towards inelastic primary earners.2 While predicting the impact of such reforms is inherently difficult, a rough estimate suggests that tax credits for the elderly and secondary earners combined with the move to individual taxation of married couples could increase the labor force significantly (by about 900,000 people if the tax credit is 1,000 euros per person/family) with relatively small fiscal cost (0.7 percentage points of GDP). While the authorities agreed with the need to reduce the labor tax wedge, they favored a more generalized tax reduction. They also pointed to constitutional constraints regarding the elimination of income splitting and noted that improving the quality and availability of childcare is essential in stimulating the labor supply of women.

Simulation of the Impact of Tax Reforms

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32. Further reform of the corporate income tax would also support growth. Recent studies find that among all taxes, corporate taxes are the most harmful to economic growth, with recurrent taxes on immovable residential property being the least harmful. Despite a comprehensive reform of the corporate income tax in 2008, there is scope for improving the tax regime for enterprises. In particular, consideration should be given to abolishing the local level trade tax, and offset it by property and inheritance taxes. Also, in line with international trends, the debt bias in corporate financing could be reduced. This can be achieved by introducing an allowance for the normal return on new equity, which, while creating an initial fiscal cost, will help increase investment, wages and growth.3 While the authorities agreed with the need to reform the trade tax and reduce the debt bias in corporate financing, they pointed out to the lack of political consensus for the former and the likely high fiscal cost of the latter, which would require a gradual approach.

33. The proposed reductions in direct taxes might require larger revenues from indirect taxes and reductions in social entitlements. Eliminating concessions in VAT and raising property and inheritance taxes will help bolster revenue. Staff estimates potential gains from these reforms at 3 percent of GDP. On the expenditure side, elimination of unconditional child transfers would have to be carefully designed to take into account all existing benefits and tax incentives. The evidence suggests that there is substantial scope to increase efficiency of education spending (Box 6), with which the authorities agreed, emphasizing their intentions to improve the quality of public finances in general.

Estimated Potential Revenue Gains from Tax Reforms

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In Germany the estimated VAT policy gap is estimated at 44 percent. The VAT policy gap is defined as the difference between collections under current law, and those that would be obtained if all exemptions not consistent with best practice and all reduced rates were eliminated, in both cases assuming full compliance with the law. In Germany the VAT policy gap largely reflects reduced VAT rates.

Increase in revenue from raising property taxes to yield the average ratio to GDP achieved in the United States, Canada and the United Kingdom.

Taxation and Labor Supply1

  • Empirical studies find that a high tax wedge significantly increases the unemployment rate by discouraging job search and making people more reluctant to accept formal jobs. Moreover, it induces trade unions to increase their wage claims, which increases the unemployment rate. For a given tax wedge, progressivity in the income tax tends to reduce involuntary unemployment since trade unions find it less attractive to claim high wages.

  • The net impact of after-tax wages on formal hours worked is small for men. Women tend to be more responsive to tax rates.

  • The responsiveness is larger for decisions on whether or not to take paid work. This may reflect, for instance, participation response by secondary earners (who alternatively engage in home production), the unemployed (who alternatively have access to social benefits), elderly workers (who alternatively retire early), or low skilled (who alternatively operate in the informal sector).2

  • Studies also show that a high tax wedge may affect the amount of on-the-job training, and the willingness to work irregular hours, as well as lead to the underreporting of formal income.

1Prepared by Ruud De Mooij.2C. Meghir and D. Philips, 2010, Labour supply and taxes, in: Dimensions of Tax Design, The Mirrlees Review, chapter 3.

Social Spending and the Efficiency of Public Expenditure

Social expenditures have declined recently, but they remain a significant part of overall expenditure in line with Germany’s per capita income. In 2008 Germany spent 27.8 percent of GDP on social protection benefits—payments for sickness, disability, pensions, unemployment, housing, family and children’s benefits. This represents a decline of 2 ¾ points from 2003, but still accounts for roughly ⅔ of public expenditure.

There is scope for increasing efficiency in public spending. Efficiency of social expenditure could be increased by the broader use of means testing instead of unconditional transfers, for example, for universal child benefits. Such measures would have to be viewed in conjunction with tax allowances. While spending on primary and secondary education in Germany is at about the OECD average, the educational attainment—as measured by scores in cross-country studies—is low, pointing to significant potential efficiency gains.


Social Spending is in line with Germany’s per capita income

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


There is scope for increasing the cost efficiency of public spending, in particular in education.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ Estimates of cost efficiency at the national level, considering 2 inputs (expenditure per student and socioeconomic background) and 2 outputs (average PISA score and homogeneity of PISA score), allowing for variables returns to scale. Source: OECD.

V. Financial Sector Stability

A. Status of the Financial System

34. The banking system’s return to broad stability reflects significant policy measures as well as economic recovery. The German authorities injected significant capital into banks and provided the safety net of sovereign guarantees to access market financing. The concerted global efforts helped stabilize the international financial system, and in line with global trends, stock prices of German banks have regained much lost ground and credit default spreads have declined. Banks have raised their capital ratios (Figure 2). Asset quality has improved as banks have written-off toxic assets and experienced reduced losses in 2010. In a few cases, banks have transferred impaired assets and non-core business to winding-up institutions.

Figure 2.
Figure 2.

Germany and Advanced Countries: Financial Sector Health, 1990-2010

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ The sample of banks included the banks that participated in CEBS stress tests in 2010 and other stock-listed European banks. For Germany the subsample includes only private banks while savings and cooperative banks, which represent a significant share of the financial system are not included. The omitted banks in Germany do not rely on wholesale funcing and maintain lower share of liquid assets.

Stock prices of banks have recovered, in line with global trends.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

Source: Thomson Financial/Datastream.

35. Stress tests conducted under the FSAP Update confirm that the majority of banks have sufficient capital buffers. Solvency tests assessed the vulnerability of the banking system under two macroeconomic stress scenarios over 2011–15, (a) a sharp “double dip” recession, which leads to an inverted yield curve; and (b) a prolonged period of very low growth. A variety of risk factors, which have a potential impact for the German financial system, were considered, including, funding risks, sovereign risk, upcoming regulatory reforms, and behavioral responses. As the Financial System Stability Assessment (FSSA) notes, on the whole, the portfolios of German banks were found to be robust against cyclical fluctuations as well as direct spillover risks from peripheral sovereign debt exposure thanks to recent improvements in capitalization levels and asset quality. The results of liquidity stress tests indicate that banks can cope with large liquidity shocks, although larger banks and some specialized private banks, given their reliance on wholesale funding, appear more vulnerable than smaller retail banks, and could face higher funding costs in the future.

36. However, pockets of vulnerabilities remain. German banks remain highly leveraged and the quality of their capital is low by international standards. Their profitability is also relatively low and expected to remain so (Figure 2). While Basel III requirements are to be phased in, the market’s anticipation of higher capitalization standards will create pressure particularly on the larger banks. In this setting, unanticipated impairments could require new capital raising efforts. Within this overall picture, certain banks under current stress and others that operate close to the regulatory minimum capital ratios face particular challenges. The authorities agreed with this overall assessment and noted that some banks have increased their capital and that they are closely monitoring the banks’ progress on their way to complying with Basel.


Large German banks are relatively robust overall, but there are some tail risks.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ The graph shows the outcome of the tests for the largest banks. The supplementary analysis for the double dip & interest rate spike scenario are based on publicly available data and thus not fully comparable with the core tests based on supervisory data. The outcome shows the capital needs by 2015 assuming that there is no policy action beforehand or a substantial change of bank behavior (other than with respect to payout or a material adjustment of business). The tests include three elements: a) Stress of sovereign debt holdings in the banking book as well as bank debt securities; b) an additional tier 1 capital buffer in 2015 of 2 percentage points and c) a more severe macroeconomic scenario corresponding to 2 times CEBS (i.e, 2.6. standard deviations in historical terms (1980-2010), accounting for the German unification).

37. Moreover, significant long-standing structural issues remain. In general, the Landesbanken problem has been punted into the future, although intensive discussions are underway with the European Commission on specific cases. While significant deleveraging has occurred, considerable work lies ahead. The authorities noted that this matter remains on the agenda and that sustainable business models are needed. However, staff encouraged a more radical approach, questioning whether Landesbanken were needed at all. In the interim, a greatly shrunken sector with strong capital buffers should be the goal. Moreover, in staff’s view the resilience of the Sparkassen is being prematurely interpreted as a sign of strength despite their strong financial linkages with the Landesbanken and new challenges they face in an increasingly competitive European landscape. Competitive forces and changes in interest rates will also challenge the cooperative sector and especially the smaller private banks going forward. In the savings and cooperative banks, additional consolidation effects can be expected (including through distressed mergers), an outlook shared by the authorities.


Landesbanken have deleveraged, reducing in particular risky assets.

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001


Stress tests suggest additional consolidation for the Sparkassen and Cooperative Banks

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

B. Managing the After-Effects of the Crisis

38. The German authorities provided sizeable support to a number of financial institutions during the crisis. Total government intervention in the financial sector as measured by the impact on public debt amounted to almost 13 percent of GDP. This includes about 1.7 percent of GDP in federal and state recapitalizations and guarantees for capital support; and the large portfolios of impaired assets/non-core business of the two winding-up institutions (and other asset run-off vehicles) at end-2010 amounted to 11.1 percent of GDP. Moreover, the federal government pledged 16¾ percent of GDP in guarantees for liquidity support. Only less than half of that amount was issued in guarantees and most of these will be run down by end 2011.

39. The legacy of the past crisis requires more forceful action. Three principles should guide such further action, a view supported by the authorities. First, the objective should be to transfer the viable parts of the distressed banks back from state care to private competitive markets. This would imply a scaling back of the authorities “silent” ownership of banks. In this regard, recent developments are encouraging. Second, a more ambitious approach is needed to isolate the “good” segments of the banks’ portfolios, guided by a realistic markdown of assets and a clarification of core banking business in the distressed institutions. The consequent reduction in uncertainty with regard to their viability should allow them to function as healthy institutions without state support. Finally, a plan to dispose of the “bad” assets in a deliberate manner but in a reasonable time frame must be drawn up. The international experience shows that protracted disposal of assets hurts their long-term value and recovery.


Public Debt Impact of the Financial Sector Support Measures

(percent of GDP) 1/

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ Public Debt Impact of the Financial Sector Support Measures for Belgium, Germany, Greece, Ireland, the Netherlands, United States and United Kingdom as of end-December 2010, for other countries as of end-April 2010. Excludes treasury funds provided in support of central bank operations. For Germany the impact on the public debt includes portfolios of impaired assets and non-core business transferred to winding up institutions amounting to 11.1 percent of GDP. For Ireland it does not include assets purchased by the National Asset Management Agency (NAMA). The assets of bad banks in France have also not been included.

Pledged Guarantees

(percent of GDP) 1/

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1/ For Germany as of end-December 2010, for other countries as of end-April 2010. Excludes deposit insurance provided by deposit insurance agencies.

C. Enhancing Preparedness for Future Crises

Restructuring authority and financing

40. The new bank restructuring law is welcome and enhances the level of preparedness. The law grants broad powers to the authorities to facilitate more timely and efficient resolution of banks that are deemed systemically relevant. The new law embodies many elements currently under discussion in European fora and is expected to be consistent with the anticipated outcome. Open questions relate to the coordination between various parties in the process of bank resolution, and to the provisions on resolution plans.

41. The bank levy to fund the new resolution fund will build up additional resources but given its target size, interim contingency arrangements remain critical. The envisaged calculation of the bank levy is focused on the bank’s liabilities side (excluding deposits and capital) and interconnectedness (nominal derivatives positions). Measuring the latter risk remains an ongoing task, and initial contributions may be lower than expected due to a ceiling on the levy linked to bank profits. The authorities are aware of these issues and are finalizing regulations on the determination of the levy. Consideration should be given to broadening the levy to other systemic financial sector participants benefitting from a stable financial sector, such as insurance. Also, contingency arrangements for the event of a substantial need of resolution funding need clarification.

42. According to staff, a phased unification of the deposit insurance schemes, along with synergies with the restructuring fund, would create greater certainty and stability. The German deposit insurance regime is fragmented, and some parts lack full transparency, legal certainty, and well-defined funding modalities in line with international best practice. Also due to broad exemptions, the voluntary deposit protection and mutual guarantee schemes currently do not need to embody the minimum elements of the1994 European Union Directive. The European Commission staff has recently been in discussions with the German authorities on the removal of the exemptions for mutual guarantee schemes. As a first step to reduce these schemes’ inconsistencies with the BCBS-IADI core principles,4 the legal certainty, transparency and funding of the regime should be enhanced by providing for a harmonized and legally-binding deposit guarantee of €100,000 in all pillars. Also, the interaction between the deposit insurance schemes and the restructuring fund should be clarified. As a next step, resilience and credibility should be strengthened by limiting the high coverage promised under the voluntary schemes.

43. The authorities recognized the relevance of the issues raised by staff but saw scope only for gradual change. They noted that depositor confidence was maintained during the crisis and expect that issues such as lack of legal certainty, transparency, and higher ex ante funding, will be addressed once the discussions at the European level are completed. Staff pointed to the possible efficiency gains to be achieved by combining the resolution fund with deposit insurance under a unified approach, but the authorities prefer to keep these separate for now.


44. The need for more proactive supervision is a key and well-understood lesson from the last crisis. This lesson is guiding a more forward-looking regulatory and supervisory process in Germany. In particular, for macroprudential supervision, the overall organizational structure and the needed instruments are yet to be established.

45. Staff expressed concern that the reform of the organizational structure for financial supervision has dragged on. After abandoning earlier plans to consolidate all prudential banking supervision into the Bundesbank, the authorities now intend to strengthen the role of Bundesbank for macro-prudential oversight based on a “10-point plan.” Under this approach, the Federal Financial Supervisory Authority’s (BaFin) micro-prudential integrated financial services supervision would be preserved. The authorities should proceed decisively in establishing clear structures and removing lingering uncertainty. Legal enhancements are needed to remove constraints on an expedient exchange of relevant information within and between institutions. Early consideration is needed to prevent risks slipping through the cracks. The authorities agree that further clarity is needed on the interactions between the Bundesbank, BaFin, and the European Supervisory Authorities, as well as the relationship between macro- and micro-prudential regulation.

46. As noted by the FSSA, macroprudential instruments should be used to contain systemic risk. While the authorities agreed with this broad objective, the specific arrangements and tools for doing so are still under consideration. The instruments under review include countercyclical capital buffers, systemic risk charges as foreseen under Basel III, and, more generally, higher levels and quality of capital (e.g., through Pillar 2 charges). The FSAP Update has estimated that, for most banks, such capital charges fall within the existing capitalization. Where needed, additional capital could be covered by contingent capital, for example.

47. While the micro-prudential supervision framework is overall sound, there are areas where it can be improved. The recent FSAP Update found supervision to be largely compliant with the Basel Core Principles for Effective Supervision. It recommended continued efforts along several dimensions: (a) regular stress testing of the banking and insurance sectors, for example, with respect to longer-term risks, U.S. dollar liquidity, and group-wide spillovers; (b) forward-looking assessment and action to head off vulnerabilities; (c) advance vetting of bank acquisitions of subsidiaries; and (d) timely reporting of emerging risk factors and shorter lags in the publication of financial sector data. The authorities are in broad agreement with these priorities and consider them part of their ongoing agenda.


The Sparkassen share of deposits placed in the Landesbanken mirrored the rise in the Landesbanken foreign investment

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

Public banks

48. Staff outlined emerging challenges for the Sparkassen. The Sparkassen hold a time-honored position in German banking and have emerged from the crisis with a demonstration of stability. Nevertheless, it is not too early to consider the longer-term challenges and stability risks they face. They have sizeable exposure to the Landesbanken: despite their storied reputation for financing small and medium firms, the Sparkassen place a sizeable fraction of their deposits to the Landesbanken. In particular, as the Landesbanken rushed at the end of the previous decade to invest in dubious projects abroad, the Sparkassen increased the share of their deposits held with the Landesbanken. The Sparkassen are also partially responsible for Landesbanken losses as part owners and guarantors in a mutual protection scheme. One large Sparkasse faced significant financial stress during the crisis. Their valued deposit base will increasingly be under contest as European financial integration—particularly internet banking—unfolds, and adequate returns will be required on the higher and better-quality capital under Basel III. With the costs they have borne for supporting the Landesbanken, it is not surprising that some Länder have allowed for private ownership, though yet without voting rights in the case of Sparkassen. A gradual shift to private ownership, while carving out their public functions, will create a level playing field for their competitors challenged by new regulatory burdens (small private banks, cooperative banks). Such a gradual transfer is a tested process elsewhere in Europe and deserves serious consideration. The authorities believe that the Sparkassen form an integral part of the German financial system, and continued stable functioning during the crisis. Any reform would need to be considered in a medium- to long-term perspective.

Effects of Raising Capital Adequacy Requirements

A regulatory increase in capital adequacy requirements in the European Union would generate modest output losses in Germany. In response to Basel III, commercial banks in the European Union may be expected to raise their capital ratios by about two percentage points on average over the next eight years, and to complete this adjustment well in advance of the deadline. A capital requirement shock is analogous to a permanent monetary policy shock, and is transmitted via the interest and exchange rate channels of monetary policy. Staff estimates a peak output loss in Germany of 0.14 to 0.22 percent assuming that monetary policy counteracts some part of the overall effect. Abstracting from monetary policy stabilization, the peak output loss in Germany is estimated at 0.64 to 0.68 percent.1 The peak output loss is higher, the faster the speed of adjustment, and occurs shortly after the end of the adjustment period.


Peak Output Losses

Citation: IMF Staff Country Reports 2011, 168; 10.5089/9781455296729.002.A001

1These estimates are based on a 0.24 percent increase in the interest rate spread, following the Macroeconomic Assessment Group, 2010, “Assessing the macroeconomic impact of the transition to stronger capital and liquidity requirements,” Financial Stability Board and Basel Committee on Banking Supervision Final Report.

VI. Staff Appraisal

49. Enduring strengths and supportive short-term policy measures have helped achieve an impressive recovery from the crisis. The proficiency of its industry, along with a sizeable, internationally-coordinated fiscal stimulus, targeted measures to support the labor market and stabilize the financial sector, helped bring output and employment above pre-crisis levels. Yet counteracting medium-term growth constraints and securing financial stability will be important to further build on these achievements and support economic wellbeing in Germany and elsewhere.

50. The very success of the recovery has generated calls on Germany to play a more prominent international role. Such a role would help assist global growth and reduce imbalances. In both respects, the scope for policy initiatives to achieve short-term gains is limited. Instead, a sustained effort will be required.

51. Political viability of the longer-term measures requires common ground between enhanced German economic well-being and contributions to the global good. German growth fluctuations have largely been driven by external developments. Despite a more prominent role for domestic demand in the past year, a durable rebalancing is needed. Better growth prospects (through a stepped-up growth potential particularly in the non-tradable sector) would generate a reinforcing combination of supply and demand responses. As the productive potential increases, confidence in a better future will raise the economy’s notably low investment rate and boost consumption growth. Such autonomous demand would create more of an international locomotive role for Germany, while narrowing its current account surplus by addressing these underlying structural factors.

52. The robust recovery offers a propitious context for tackling long-standing structural problems. The commitment to fiscal consolidation is strong, and the German leadership in this area carries potential medium-term benefits for Europe. In other areas, however, the political momentum for reform appears weak. Stepping up potential growth would require important measures in areas such as tax policy and educational reform, which while widely understood, need to move up in policy priority and implementation. In financial sector policy, the new bank resolution framework is welcome, but in other long-standing matters, German authorities have been generally reactive to European initiatives. The political constraints to action will only increase if these challenges are confronted in a low-growth environment.

53. The growth agenda must be multi-pronged but supported by specific measures to be effective. The goal is to increase labor participation, deploy labor productively and complement it with physical investment and innovation, especially in areas outside Germany’s traditional strengths. Tax policy to raise labor participation and improve the investment climate would need to be complemented by educational reform, enhanced provision of risk capital and a more efficient insolvency process.

54. The government’s fiscal consolidation path is appropriate but consolidation must build room for responding to negative surprises and for fostering growth. With the output gap closing, longer-term considerations require lowering the public debt-to-GDP ratio to regain lost ground, enhance its fiscal credentials, and support the European Stability and Growth Pact. A reassessment of the speed of consolidation may be needed if growth turns out to be significantly weaker than expected. Moreover, space is required within the consolidation envelope for initiatives to foster a growth agenda.

55. The financial system is broadly stable but pockets of vulnerability remain. Improved capital ratios at banks imply that they could absorb considerable stress. Nevertheless, German banks remain highly leveraged, achieve low profitability, and the large banks remain highly dependent on market funding. These vulnerabilities apply with particular force to certain financial institutions, most prominently some Landesbanken. The delays in data publication and the lack of transparency in crucial areas are troubling. Moreover, while the overall level of direct exposure to the European periphery is limited, some banks are more exposed than others, and indirect effects through banks outside of Germany could have cascading effects.

56. Forward-looking actions to limit systemic risk are required in four areas:

  • The legacy of the crisis requires continuing attention. The effort must be to carve out viable segments of the distressed banks and return them to private hands. The distressed assets should be sold at a deliberate pace, avoiding fire sales but minimizing delays that could cause the assets to lose value.

  • Clarity on the regulatory and supervisory regime is overdue. To prevent risks slipping through the cracks, early consideration is needed to clarify the content of macro-prudential oversight likely to be designated to the Bundesbank, the relationship between macro- and micro-prudential regulations, and the necessary information sharing requirements.

  • For the various deposit insurance schemes, a move towards common, statutory payout obligations across the pillars could be a first step to their eventual unification to realize economies of scale. Unified statutory schemes would also allow for the possibility of the use of their resources for early intervention and, hence, realize synergies with the proposed restructuring fund.

  • A gradual shift of the Sparkassen to private ownership, while carving out their public functions, is a tested process elsewhere in Europe and deserves serious consideration.

57. It is recommended that the next Article IV consultation with Germany be held on the standard 12-month cycle, in accordance with the Decision on Article IV Consultation Cycles (Decision No. 14747-(10/96) (9/28/2010)).

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.

ILO definition.

Deflated by the national accounts deflator for private consumption.

Net lending/borrowing.

Excluding supplementary trade items.

Data for 2011 refer to March.

Data for 2011 refer to the change in February.

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

Data for 2011 refer to February.

Data for 2011 refer to March.

Based on relative normalized unit labor cost in manufacturing. Data for 2011 refer to February.