OECD Economic Outlook, Volume 2022 Issue 2

Germany

The economy is projected to grow by 1.8% in 2022, contract by 0.3% in 2023 and recover by 1.5% in 2024. Uncertainty is high amidst strong energy price volatility. High inflation is reducing real incomes and savings, damping private consumption. Despite weakening external demand, export growth will recover through 2023 due to easing supply chain bottlenecks and a record-high order backlog. If energy saving requirements are not met during the winter, gas rationing would imply severe production disruptions.

The fiscal deficit will widen in 2023, before contracting in 2024. It is crucial that energy support measures establish strong incentives for gas savings and target vulnerable households. Corporate support measures should address liquidity concerns and not impede necessary structural change. Improving planning and approval processes and capacity, particularly at the municipal level, would accelerate the energy transition and digitalisation. Skilled labour shortages should be addressed by raising the labour supply of women, elderly and low-skilled workers, improving training and adult learning, and facilitating the recognition of the qualifications of migrants and refugees.

Uncertainty and high inflation exert a drag on growth

Following Russia’s invasion of Ukraine, GDP growth slowed to 0.1% (seasonally adjusted quarterly rate) in the second quarter of 2022 and 0.3% in the third quarter. High inflation and plummeting consumer confidence have limited the rebound of private consumption that had been imparted by the lifting of pandemic containment measures and high excess savings. Heightened uncertainty, high energy prices and material shortages have hurt manufacturing and construction as well as investment. Business confidence plunged in September, but stabilised in October. High order backlogs and easing supply chain bottlenecks are supporting exports. Annual consumer price inflation rose to 10.9% in September with the phase-out of fuel and public transport subsidies and continued to rise to 11.6% in October. Producer prices rose by 45.8% over the year to September. Household inflation expectations for one, five and ten years ahead averaged 8.2%, 6% and 5.5%, respectively, in September. The labour market remains robust amid intensifying labour shortages, but annual negotiated pay rose only by 2.9% in the second quarter of 2022, resulting in a real wage decrease of 4.4%.

Germany 1

Source: Federal Statistical Office; ifo business surveys; and GfK.

Statlink

Germany: Demand, output and prices

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Germany 2

1. Harmonised index of consumer prices.

2. Harmonised index of consumer prices excluding food, energy, alcohol and tobacco.

Source: Federal Statistical Office; and Eurostat.

Statlink

Prior to Russia’s war of aggression against Ukraine, Germany was highly dependent on Russian gas, oil and coal, with around one-third of primary energy supply coming from Russia. A rapid diversification of energy suppliers, the EU coal embargo and the shutdown of Russian gas pipelines have strongly reduced Russian energy imports. Despite gas storage levels already reaching 100% and the planned opening of two LNG terminals by the end of the year, gas consumption needs to be reduced by around 20% to prevent gas shortages during the winter. Industry has already reduced gas consumption by around 25% (compared to the average over 2018-21), including through output reductions in some energy-intensive industries. Energy savings will be further incentivised by a gas auction mechanism for firms to supply their excess gas capacity. Households and small firms reduced gas consumption by 31% due to high prices and relatively warm weather in October. Electricity production using gas has been reduced and replaced by phased-out or reserve coal power plants which have been reactivated. The three remaining nuclear power plants, which were scheduled to close on 1 January 2023, will continue operating until mid-April 2023. So far, Germany has received 1 million refugees from Ukraine (equivalent to 1.2% of Germany’s population).

Fiscal policy is supporting households and firms

The fiscal deficit will widen in 2023 due to broad energy price support. Pandemic-related support programmes were phased out in June, but three energy support packages estimated at EUR 95 billion (2.6% of GDP) in direct expenditures and an energy support fund of EUR 200 billion (5.5% of GDP) financed by credit allowances have been announced. The support packages include various measures to support real incomes, comprising both targeted transfers through social assistance and housing allowances, and non-targeted ones such as one-off payments to all employees, pensioneers and students, and adjustments of the income tax schedule. The VAT rate on gas was lowered from 19% to 7% in October. These measures can be realised within the current budget, as high inflation and repayments of COVID‑19 support grants led to higher-than-expected tax revenues. For 2023, electricity price support will amount to EUR 43 billion and will be partly financed by a windfall tax on electricity producers. The energy support fund will finance gas price support for households and firms up to a total of EUR 40 billion in 2023 as well as liquidity support, equity injections and grants for firms. The electricity and gas price support will subsidise around 80% of past average consumption through transfers, limiting consumer price increases in 2023 to about a doubling from 2022 prices, and maintaining market prices for any consumption exceeding 80% of past average consumption. Energy price support measures are planned to be phased out in April 2024.

To reach its ambitious climate targets, the government plans to invest around EUR 200 billion until 2026, with fiscal incentives to crowd in private investments playing a major role. It also envisions a significant increase in military spending of EUR 100 billion over the next few years to upgrade military equipment. Most of these debt-financed investments as well as the energy support fund will be funded through shadow budgets, the spending of which is excluded from the national debt brake that is planned to be reinstated from 2023. Exact spending plans for the shadow budgets are currently missing, but capacity constraints in the construction sector and long and complex planning and approval procedures will likely slow the disbursement of funds.

The recovery is hampered by the war in Ukraine and high energy prices

High inflation and plummeting consumer sentiment will weigh on private consumption. Investment remains subdued due to high uncertainty and rising interest rates, but will eventually pick up due to high corporate savings and investment needs related to the relocation of supply chains and renewable energy expansion, as well as rising public investment. High energy prices will weigh on energy‑intensive industries, but exports should continue to recover due to a substantial order backlog and easing supply chain bottlenecks. Inflation will stay high due to the pass-through of energy and producer prices to consumers, the depreciation of the euro and rising wage pressures, but gradually moderate over the projection period. Wage growth will rise, helped by the minimum wage increase from 48% to 60% of the median wage in October 2022, continued labour shortages and pressure from unions to preserve the purchasing power of workers. Fiscal tightening is projected for 2024.

A severe downside risk to the projection arises from potential gas rationing in the next two winters if planned fiscal support measures do not sufficiently preserve price incentives for gas savings. New waves of the pandemic could further depress private consumption or exacerbate supply chain bottlenecks. Rising interest rates could cause strong corrections in housing markets, affecting financial markets. On the upside, a quicker end of the war could restore investor and consumer confidence and lower energy prices.

Expanding renewables to raise energy security

Energy support measures should be better targeted on vulnerable households and firms and establish strong incentives for gas savings. To expand renewable energy supply, it is crucial to continue accelerating complex planning and approval procedures at the municipal and Länder level. Speeding up the digitalisation of the economy requires more investments in digital infrastructure, a more rapid modernisation of the state and better coordination of policies and administrative procedures across levels of government. Increasing the efficiency of public spending by effective use of spending reviews, reducing regressive and environmentally harmful subsidies and tax exemptions, and improving tax enforcement could free up additional resources for necessary public investment. To address rising labour shortages, which also risk derailing private and public renewable energy investment, labour market participation of women, low‑skilled and elderly workers needs to be raised by setting the right tax incentives and improving training and adult learning policies. Boosting skilled migration and facilitating the labour market participation of Ukrainian refugees, including through better access to childcare, is also key.