KEY ISSUES Context: Growth is benefiting from lower energy prices and euro depreciation, and the labor market is strong. The external position remains substantially stronger than implied by medium-term fundamentals as the current account surplus reached another historical high. The fiscal position is healthy, corporate and household balance sheets are sound. Low interest rates are compounding chronically weak bank profitability and hurting life insurers’ solvency. The population is aging fast despite record immigration, which will increasingly harm growth prospects after 2020. Policy priorities: Further progress is urgently needed to raise potential growth while generating beneficial spillovers to the rest of the euro area and lowering the large current account surplus: Step up investment addressing weaknesses in public infrastructure to strengthen potential output and domestic demand. To facilitate this process, put in place new institutions that enable better planning and coordination of public investment at the local level. Enhance competition to foster a more productive services sector. Reduce disincentives for women to work full time as a way to mitigate the adverse effects of an aging population on labor supply. Expand the macroprudential toolkit to better address potential future excesses in the housing sector. Ensure that life insurance companies maintain sufficient capital buffers to withstand a prolonged period of low interest rates.
This statement provides information that has become available since the issuance of the staff report. The information does not alter the thrust of the staff appraisal.
Following the expiration of the European program with Greece last week, the risk of renewed stress in the euro area has increased. So far, the reaction of financial markets has been relatively muted and contagion has not been significant. The yield on the 10-year Germany government bond has fallen by 26 basis points since the issuance of the staff report, reflecting safe haven effects. The DAX stock market index has declined by 6 percent, with bank stocks especially hard hit. CDS spreads for the largest four banks have increased by 14 basis points on average.
For Germany, the main short-term risk is that turmoil will spread and undermine confidence in the economic expansion. This would likely weaken private consumption and delay the projected recovery in private investment. Successful management of this risk will depend on the timely deployment of the available ECB policy tools. In the medium-term, there is a need for a concerted effort to accelerate integration within the euro area and strengthen firewalls. The upcoming euro area Article IV report will elaborate on these policy challenges.
The Financial Stability Committee (FSC) has recommended an expansion of the German macroprudential toolkit, in line with staff’s advice. Following its June 30, 2015 meeting, the FSC recommended that the Federal government initiate legislation to give the Federal Financial Supervision Authority (Bafin) authority to introduce measures constraining mortgage loan eligibility, such as limits of loan-to-value ratios, debt-to-income ratios, and debt-service-to-income ratios, as well as minimum amortization requirements. The Committee underscored that activation of such instruments is not envisaged at the moment.