2017 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Germany
I would like to convey my authorities’ gratitude for insightful discussions during the Article IV. My authorities find their views well-documented and the staff assessment candid and balanced.
The German economy has continued a strong, sustainable, balanced, job-rich and inclusive growth performance. The German government projects a working-day adjusted growth rate of 1.8 percent for 2017 and 1.6 percent for 2018. The public debt ratio has continued to gradually decline towards the ceiling of 60 percent of GDP, the share of climate-friendly energy sources has been increased and private balance sheets remain healthy. Growth continues to be driven by domestic demand while lower oil prices and a steady strengthening of investment income are reflected in the balance of payments. Employment has reached record levels. Participation rates have grown steadily and a well-developed redistributive tax and transfer system has kept income inequality in check. We broadly agree with staffs views on the macroeconomic outlook and risks. However, as in the past we see a much smaller undervaluation of the REER (in 2016 at around 6 percent) than staff.
Structural reforms have been crucial to achieve this sustained growth performance. Successful labor market reforms in the past as well as reliable social safety nets have underpinned inclusive growth in Germany. In recent years, the authorities have continued to build on these achievements and adopted additional reforms.
Reforms have aimed at encouraging more flexible working lives and ensuring fair conditions for workers through the introduction of the so-called Flexirente and a comprehensive statutory minimum wage which in real terms (USD PPPs) is the highest among major advanced economies. The German authorities also adopted a law on greater pay transparency and amended provisions for temporary staff.
Another set of reforms has focused on social inclusion and addressing concerns about poverty through promoting continuing education and training, the introduction of programs to support workers after periods of caring for children or relatives as well as the parental allowance with a partnership bonus. In addition, the supplementary child allowance has been increased, targeted benefits to stabilize the financial position of single parents were introduced and housing benefits reformed in line with the trend in rent and incomes.
Tackling long-term unemployment has been another priority. Efforts were made to intensify job coaching, improve wage subsidies and support workers who require special support due to health impairments or are living with children in a community of need.
Going forward, the authorities recognize that a well-funded education system and the integration of refugees into the labor market are the major challenges for inclusive growth and mitigating relative poverty risks.
Continued progress is being made on digitalization with several policy initiatives. These include the promotion of digitization and competence in SMEs as well as the development of a modern regulatory framework for the digital world. Instruments to support innovation and venture capital, such as the High-Tech Start-up Fund and the INVEST program, are evaluated on a regular basis by external institutions. They certify that measures are successful and funds are used adequately.
The authorities agree that reducing the regulatory burden in the services sector may lead to an increase in productivity. They are scrutinizing regulations not only in terms of potential productivity gains but also with regard to their protection of health, safety and consumer interests.
Fiscal policies will remain growth-friendly and an anchor of stability in the euro area. As public debt is gradually approaching the debt ceiling, supporting the sustainability of public finances in the face of demographic challenges and rebuilding buffers for unforeseen developments deserve high priority. With a view to long-term demographic challenges it is key to look beyond 2030, as adverse dynamics will accelerate considerably with “baby boomers” entering retirement. The national debt brake, which essentially prescribes a close-to-balanced budget, was not least geared to frontload the required consolidation by bringing the debt ratio well below the ceiling of 60 % of GDP. It will be important for the aging German society to keep this strategy over the long term. The current fiscal stance also rightly reflects the favorable cyclical position and growth outlook for Germany. Public investment and priority expenditures have been increased substantially in recent years. As capacity constraints have been coming more to the fore, recent initiatives such as the creation of a Federal Infrastructure Corporation for Highways and other Federal Trunk Roads as well as greater financial support to subnational governments should allow for better project selection and investment planning going forward.
Regarding the Fund’s recommendation towards improved revenue forecasts, several caveats apply: for the long run, there is empirical evidence that the conditional tax revenue forecasts are not systematically downward biased. There are episodes in which revenue forecasts show upward (early 2000s) or downward bias (recent years). In these years, unexpected revenue shortfalls or windfalls play a role. It is, however, not reasonable to project high revenue growth due to windfalls into future years. The methodology is being constantly evaluated and – if possible – improved. Recently, the forecast of the assessed income tax (fraction of PIT) has been augmented by better taking into account the effects of increasing taxation of pensions, which plays an increasing role in the coming years and should lead to higher revenue growth in this tax category. Moreover, it is important to fully account for the institutional setting for tax revenue forecasts in Germany. The working group on tax revenue forecasts is an independent technical working group. Based on individual forecasts by the Ministry of Finance, Deutsche Bundesbank, Research Institutes, Council of Economic Advisers, and Länder the working group decides on a consensual revenue forecast. Forecasters are free in their choice of forecast models.
The external sector in Germany remains strong as a result of private demand and supply decisions in international trade and investment. The authorities closely observe the high current account surplus. Except for a small fiscal policy gap, there are no deviations from desirable policies identified in the EBA exercise for Germany. The authorities’ fiscal strategy is comprehensively discussed above but in this context, we would like to point out that some additional loosening of fiscal policies is currently being discussed in the run up to the general election in September 2017. More specifically, steps to reform pensions as well as reducing the tax burden on labor are envisaged as priorities for the next election period. In addition, transitory effects from lower commodity prices and a favorable euro exchange rate will soon cease. These factors as well as brisk domestic demand support the expectation of a reduced external balance in the years to come. The sustained increase in investment income reflected in the BoP is fundamentally justified by a rapidly aging population in Germany and greater returns on job-rich investments outside of Germany.
Continued robust wage and price growth will further strengthen domestic sources of growth. Looking at OECD data, average wages (USD PPPs) in Germany have increased already more strongly than in any other major advanced economy since 2010 thanks to the strength of the domestic economy and an increasingly tight labor market. Real wage growth has accelerated over the last three years with annual increases close to or above two percent which are the strongest wage gains in over two decades. While wage setting is left to social partners, in light of favorable economic conditions, these developments are likely to persist for the foreseeable future and will support growth and the normalization of monetary policy in the euro area. Staff’s suggestion for a more proactive public communication on wages is not supported by past experience. The decentralized process for wage bargaining is highly valued in Germany and communication by officials has generally been seen as unhelpful interference or a politicizing of negotiations by social partners.
Concerning the housing market and financial sector assessment, we broadly concur with the findings of the staff report. The banking and insurance sectors have to shore up profitability and resilience in a challenging environment with low interest rates and a new regulatory framework. Increases in house prices appear to be driven mainly by fundamentals and the extraordinarily low level of mortgage rates. Continued vigilance is, however, needed especially for certain regional markets that are experiencing rapid price growth. Vigilance is also needed as regards the growth of loans for house purchases, which have picked up in recent months driven by very favorable financing conditions as well as buoyant household demand. We remain committed to tackle and overcome the significant data gaps in the mortgage sector in particular. At the current juncture, however, preference has been given to existing initiatives on the European level, reflecting subsequent efforts following the recommendation of the European Systemic Risk Board in October of 2016 on closing real estate data gaps.