IFO economic forecast 2012/2013

December 13, 2012

The German economy looks set to contract in the fourth quarter of 2012, before staging a recovery that is expected to be modest initially in 2013. These are the indications of the Ifo Business Climate Index, which recently rose clearly after showing no signs of any upswing in the previous months. The euro crisis is responsible for the poor economic situation at present. Real gross domestic product, at a 2/3 uncertainty interval of -0.6 % to 2.0 %, should therefore only in-crease by 0.7 % on annual average in 2013. Boosted by domestic demand, the economy looks set to pick up again in the year ahead, as long as the European debt crisis does not escalate any further. However, no significant growth in employment is expected during this period.

World economic situation

The world economy has been steadily cooling down since the middle of last year. This has been apparent in all key economic regions, albeit to differing degrees; and world trade has continued to slow down over the past 18 months as a result. The slackening of global economic momentum since mid-2011 is primarily due to the huge adjustment processes that are currently taking place in the euro area. Both public and private players have started to consolidate their finances, which is having a major negative impact on demand for consumer and capital goods. Moreover, concerns about the solvency of the State and banking systems in the crisis-afflicted countries of the euro area, as well as the risk of disorderly exits from the European Monetary Union, are unsettling investors, consumers and producers worldwide.

Many private households in the USA have also been engaged in attempts to reduce their debt to sustainable levels. This process has curbed consumption. Uncertainty as to the future orientation of financial policy has also had an adverse impact in the USA. The threat of dramatic tax increases and expenditure cuts triggered by a “fiscal cliff” at the beginning of next year has also been causing concern for some time, and not just to investors in the USA.


World economic developments in the forecasting period will mainly depend upon the euro crisis. This forecast is based on the assumption that there is no further escalation in the euro crisis during the forecasting period. This presupposes that the crisis-afflicted countries closely stick to a course of fiscal consolidation and implement planned structural reforms in several areas. However, it also means that other countries in the euro area like France, for example, implement measures that have already been decided upon, or are at least currently envisaged, to reduce their public deficits and improve their international competitiveness.

Outlook for the world economy

If this baseline scenario materializes, the world economy should not slip into a recession during the forecasting period. However, nearly all of the key advanced and emerging economies will experience a period of economic weakness in the winter of 2012/13. World economic expansion should subsequently accelerate slightly over the course of 2013. In many emerging economies economic stimulus measures that are either in the pipeline, or have already been implemented, will help the economy to rally next year. Moreover, disposable income should continue to rise sharply in these countries, which should give an additional boost to private consumption. Advanced economies also look set to post slightly higher growth rates. This is mainly due to two factors: the contractive fiscal policy impetus in the euro area will probably be weaker than in 2012 on the one hand; while the domestic demand dynamic in the USA should gradually pick up after the fiscal policy damper at the beginning of the year. However, in spite of all this, the consolidation efforts required on the part of the private and public sector in nearly all advanced economies should slow the pace of growth.

Economic outlook for the euro area

The economic performance of the euro area looks set to fall in the winter months. This is due to contractive financial policy, the poor situation in the labour market, restrictive financing conditions and insecurity regarding the future of the euro crisis. In view of their need to reduce debts, private households will further reduce their expenditure. Insofar as the assumptions forming the basis of the forecast materialize, however, the situation should not deteriorate any further next year. In the second half of 2013 private investments look set to stabilise slightly as a result. This should be supported by the continued pursuit of an expansive monetary policy and an uptick in exports. The latter should be clearly boosted by the economic upturn in emerging economies and slightly stronger momentum in the USA. The growth rates of gross domestic product in the euro area can therefore be expected to turn positive over the course of the year ahead. However, a fully-fledged recovery is not yet in sight.

Overall, gross domestic product in the euro area will drop by 0.5% this year, and by 0.2% in the year ahead. The economic differences between individual EU member states will continue to increase during the forecasting period. Aggregate production in the crisis-afflicted countries (with the exception of Ireland) looks set to contract further. After a clearly weak phase at the turn of the year, more stable economies like Germany, Finland and Austria, on the other hand, will leave the downturn behind them in 2013.

The weak economic situation should push up the unemployment rate to 11.4% this year and 12.2% next year, with significant regional differences. In view of the high rate of underemployment, wage increases should be very moderate, leading to a successive slowdown in the inflation rate. The impact of past increases in excise duties should also gradually fade. The inflation rate is therefore expected to drop to 2.5% this year, before falling further to 1.8% in 2013.

Situation of the German economy

After a strong start, overall economic output in Germany increasingly lost momentum over the course of 2012. Lingering uncertainty as a result of the European debt crisis clearly curbed the upward forces of domestic demand. Out of all segments of domestic demand, investment in equipment and machinery was the most seriously affected and fell sharply over the course of the year, despite extremely favourable financing conditions. Investments in buildings also dropped until the middle of the year. This was mainly due to a slump in public sector investment in construction after the subsidies of the economic stimulus packages agreed upon during the last recession expired at the end of 2011. In residential construction, on the other hand, low interest rates continued to stimulate the market. Growth was particularly boosted by international trade, although impulses have clearly weakened in recent months.

The economic slowdown has also impacted the labour market. The number of persons in work stopped increasing recently, while the number of hours worked dropped considerably. Companies have obviously been able to offset lower demand for staff by reducing overtime and the balances on working-time accounts. The fact that unemployment has been increasing since the spring is primarily due to a reduction in active labour market policy.

Outlook for the German economy

In the last quarter of 2012 overall economic output should fall by 0.3 %. However, from today’s standpoint, Germany does not look set to slip into an outright recession. The Ifo Business Climate Index rose again slightly in November for the first time in six months, and there was a clear improvement in the outlook component of the index. The economy therefore looks set to recover slightly in the first quarter of 2013; while gross domestic product should increase by 0.2%. On balance, overall economic production should stagnate in the winter months of 2012/13.

Over the course of the rest of 2013 the economy should experience an upswing. If the euro crisis does not escalate and remains in line with the baseline scenario, domestic upward forces and rising demand for German export goods from outside the EU should boost the economy. Private consumption and investment in equipment and machinery should pick up clearly as a result; and exports should also increase. International trade will not, on balance, make any direct contribution to an increase in gross domestic product, as imports will be equally widespread due to livelier domestic demand.

All in all, average gross domestic product should only be 0.7% higher than the previous year’s level in 2012. Over the course of 2013 it should subsequently increase by 1.4 %. However, due to the low starting level caused by the weak winter, the average annual growth rate in GDP in 2013 will be just 0.7%. Compared to the Ifo Institute’s June forecast, this represents a considerable downward adjustment. This is due to the fact that the euro crisis has thrown the German economy off course later than expected i.e. in the present winter months, rather than last summer according to our current estimates. According to our present forecast, the delayed recovery will not start until 2013 as a result.

There will be no significant growth in employment. The number of persons employed in 2013 should only be around 35,000 people higher than the previous year’s value. The number of unemployed will increase during the winter months, but should gradually fall again over the course of the year ahead. Due to the high starting level, however, there will be an annual increase of 60,000 persons in 2013. The unemployment rate is expected to rise slightly from 6.8% this year to 6.9% next year.

The inflation rate is forecast to be 2.0% in 2012 and is expected to weaken to 1.6% next year. The general government deficit should drop to 0.1% this year and remain at this level in the year ahead. General government gross debt looks set to total 81 ½ % this year and drop to around 80½% in 2013.

source: ifo


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