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Upswing of German Economy Prevails, Bolstered by Strong Domestic Demand

Press Release of June 25, 2015

GDP is set to grow by 1.8 percent this year and 1.9 percent next yearthe global economy is slowly picking up steam, and the euro area is showing solid growth performancepossible risks such as Greece leaving the euro area are creating a strain on the economy

The German economy is continuing on an upward trend but, due to unexpectedly weak growth at the beginning of the year, will not perform quite as strongly this year as initially expected: DIW Berlin’s economic experts are forecasting a rise in gross domestic product (GDP) of 1.8 percent for the current year. This figure is lower than an earlier estimate from March, when they were expecting growth to hit 2.2 percent. They are anticipating similar growth for next year with a rise of 1.9 percent. Consumer spending is expected to be a major driver of this growth, thanks in part to a continuing increase in the number of new jobs created. Businesses, on the other hand, are holding back somewhat on investment spending. It cannot be denied that they are facing many risks: a breakdown in negotiations with Greece, followed by Greece leaving the euro area, could result in turmoil in financial markets. A renewed flare-up of the conflict between Russia and Ukraine would also have a negative impact on the global economy and consequently on investment activity.

IN BRIEF

Marcel Fratzscher (President of DIW Berlin): “The German economy currently appears to be stronger than it actually is. Growth of 1.8 percent of GDP sounds good, at first glance, but there are numerous special factors behind it, such as the low oil price and favorable euro exchange rates for German exporters. The risks, however, are enormous: if negotiations with Greece were to fail and it were to leave the euro, this would have disastrous consequences for Europe as a whole and also damage the German economy. We must not underestimate the risk of contagion from the Greek crisis. Companies are still investing much too little and have so far not even reached pre-crisis levels, partly because of these uncertainties.”

Ferdinand Fichtner (Head of the Department of Forecasting and Economic Policy at DIW Berlin): “The global economy is beginning to pick up pace again after a weaker-than-expected first quarter. This is mainly due to the industrialized countries which are cranking up the global economic engine because consumers there have more money in their pockets as a result of low energy prices and an improving situation on the labor markets, leading to a rise in consumer spending. In contrast, major emerging economies such as China are growing more slowly for structural and cyclical reasons – this could also be a burden on German exports. On the positive side, however, the economy in the euro area is continuing to improve. But we should in no way ignore the risks surrounding the Greece issue.”

Simon Junker (Deputy Head of the Department of Forecasting and Economic Policy at DIW Berlin and an expert on the German economy): “The German economy is continuing on an upward trend, although we had to revise our spring forecast down 0.4 percentage points to 1.8 percent – but this is simply due to weaker-than-expected production in the first quarter. Going forward, the economic outlook is more optimistic: exports are likely to pick up pace again thanks to the recovery of the global economy and the euro area. Growth continues to be stimulated by the strong domestic economy, as employment continues to rise, unemployment is falling, wages are increasing, and inflation remains very low.”

Kristina van Deuverden (Research Associate in the Department of Forecasting and Economic Policy at DIW Berlin and expert for public finances): “The situation of public finances in Germany is and will continue to be favorable. The surpluses are largely structural in nature and will therefore remain even if cyclical effects are accounted for. There is therefore scope which fiscal policy should use to implement growth-oriented economic policies. This includes not only expanding investment but also improving incentives to work and reducing social security contributions. By international standards, it is not tax revenues that are proving to be an above-average burden in Germany but high social security contributions; these make it expensive to work and so potentially curb growth. The proper mix of taxes and social security contributions should now be given priority.”

German Institute for Economic Research (DIW Berlin)

The German Institute for Economic Research (DIW Berlin) is one of the leading economic research institutions in Germany. Its core mandates are applied economic research and economic policy advice as well as provision of research infrastructure. As an independent non-profit institution, DIW Berlin is committed to serving the common good. The institute was founded in 1925 as Institut für Konjunkturforschung (Institute for economic cycle research). Since 1982, the Research Infrastructure SOEP (German Socio-Economic Panel Study), a long-term study, is affiliated to DIW Berlin. The institute has been headquartered in Berlin since its founding. As a member of the Leibniz Society, DIW Berlin is predominantly publicly funded.

Industrialized countries are principal drivers of global economic recovery

The global economy is picking up speed after an unexpectedly weak first quarter in 2015. While emerging economies such as China have seen growth gradually losing momentum due to structural adjustments and a cyclical downturn in recent quarters, growth in industrialized countries – driven largely by a recovery in consumer spending – is quite strong overall. Thanks to gradual improvements in the labor market, household income is rising. This is expected to have a stimulating effect on investment, although growth rates will likely be moderate. As the US economy is picking up and growth in the euro area and Japan remains strong, expansion of the global economy as a whole is expected to accelerate slightly. Economists at DIW Berlin are predicting a global growth rate of 3.5 percent for this year and 4 percent for next year.

The euro area economy is also expected to put in a solid performance: gradual improvements in the labor market, less restrictive fiscal policy, and increasing confidence are stimulating consumer spending. The weak euro is strengthening exports. DIW Berlin is therefore predicting euro area growth of 1.3 percent for the current year and 1.5 percent for next year.

German economy is picking up

The German economy is being driven by strong domestic demand. Employment continues to grow, if at a somewhat slower pace. According to the DIW forecast, the unemployment rate will fall to 6.4 percent this year and 6.2 percent next year. Given this environment, strong wage increases are expected for both years, additionally stimulated this year by the introduction of the minimum wage. However, purchasing power is dampened, as oil prices have stopped falling and inflation – previously very low – is rising slightly; DIW Berlin is predicting an inflation rate of 0.6 percent for this year and 1.2 percent for next year. Overall, however, DIW Berlin expects real incomes to show strong growth and consumer spending therefore to be a key driver of growth.

Despite positive developments in the domestic economy, growth in investment is sluggish and, relative to nominal GDP, is expected to remain below pre-crisis levels. This can be attributed to the dampening effect of continued uncertainty regarding both euro area stability – as negotiations with Greece drag on – and tensions between Russia and Ukraine. Exports, which were weak at the beginning of the year due to global economic developments, are expected to pick up. Imports are also expected to rise as a result of strong domestic demand. Germany’s current account balance is predicted to remain very high, at almost 8.5 percent both this year and next.

Continued public budget surpluses

According to estimates by DIW Berlin, public budgets in Germany are continuing to develop well and are expected to show surpluses of 0.5 percent of nominal GDP for both this year and next year, slightly below the ratio of the previous year. This is largely due to higher expenditures – not least as a result of expanding pension benefits, such as the newly introduced early retirement scheme, which allows retiring at the age of 63 for employees meeting certain conditions and will for the first time be effective for the entire year.

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