OECD Economic Outlook, Volume 2024 Issue 1

Germany

The economy is projected to grow by 0.2% in 2024 and 1.1% in 2025. Continued disinflation and rising wages will support real incomes and private consumption. Private investment will gradually pick up, helped by the relocation of supply chains, digitalisation and renewable energy expansion. It will be supported by high corporate savings and slowly declining interest rates. However, policy uncertainty related to the financing of planned fiscal incentives for green investments will continue to weigh on investor confidence. Exports will slowly recover as global demand strengthens.

Increasing public spending efficiency, reducing environmentally harmful tax expenditures and enhancing tax enforcement would create fiscal space to address a large infrastructure backlog and support green investments. This should be combined with introducing more flexibility in the national fiscal rules. Continuing to reduce the administrative burden, digitalise the public administration and improve infrastructure implementation capacity, particularly at the municipal level, is also essential to raise public and private investment. Skilled labour shortages should be addressed by strengthening the work incentives of women, older workers and low-income earners as well as improving education, training and adult learning policies.

Private consumption has started to recover but investment has weakened

GDP declined by 0.3% in the fourth quarter of 2023. Strong nominal wage gains and declining inflation boosted household purchasing power and private consumption. High interest rates and increased policy uncertainty about the financing of planned investment incentives for the green transition have weighed on business and residential investment. Industrial production was 4.9% lower in February than a year earlier but increased compared to January 2024, with energy-intensive production rising by 4.2% on the month, helped by falling energy prices. Business confidence started to recover in February and March. Producer prices were 2.9% lower in March than a year earlier. Despite an increase in carbon prices for transport and heating, and the phase-out of energy price support measures in January, energy prices have continued to fall, leading to a decline in headline inflation to 2.3% in March. Core inflation is still high at 3.2%, mainly due to services price inflation and also the phase-out of VAT reductions for hospitality sectors in January 2024. Tax-exempt inflation compensation premiums and wage bargaining outcomes led to a strong rise in nominal wages by 5.3% in the fourth quarter of 2023. The unemployment rate was stable at 3.2% in February, with vacancies remaining high.

Export values have proved relatively resilient in recent months despite the negative impact of tight financial conditions on global demand for investment goods and rising global tensions. However, the value of total exports in January and February was still 2.1% below the same period one year earlier. Exports to non‑EU countries decreased in March by 0.8% compared to February. The large export order backlog will continue to provide some support for exports, particularly in the automobile industry, ahead of a recovery in global demand.

Germany: Activity and confidence indicators

1. Prices of natural gas sold to industry.

2. Electricity prices, when delivered to special contract customers.

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

Statlink

Germany: Demand, output and prices

Statlink

Germany: Inflation and labour market indicators

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

Fiscal policy will be restrictive

The fiscal stance will tighten in 2024-25 by around 1.6% of GDP over the two years. This partly reflects the impact of the November 2023 Supreme Court ruling that declared the use of special funds to finance investments in consecutive years as unconstitutional. The ruling has led to a reduction of available funds in the Climate and Transformation Fund by EUR 60 billion and the closure of the energy support fund. This will significantly reduce spending on public investments and fiscal incentives for private investments for the green transition. The closing of the energy support fund has led to the phasing out of energy price support measures in January and the cancellation of planned grid charge reductions.

The Supreme Court ruling greatly increased uncertainty about future spending from the Climate and Transformation Fund, including plans to extend subsidies to reduce energy costs for businesses until 2030. To ensure that the 2023 budget complied with the ruling, the national debt brake had to be suspended for 2023, following previous suspensions in 2020-21 due to the pandemic and in 2022 due to the energy crisis. The 2024 budget had to be revised to comply with the ruling, with spending cuts in several areas, including reductions in tax expenditures on diesel used by agricultural producers. Medium-term uncertainty for investors remains high as several projects related to the Climate and Transformation Fund were planned for 2025-26, and the revised 2024 budget does not address the financing issues for these projects in the coming years.

The economy will slowly recover due to rising private consumption

GDP growth will gradually improve driven by a recovery of private consumption, as households’ purchasing power rises amid high nominal wage increases and receding inflation. The gradual easing of tight financial conditions from the second half of 2024 will allow business and residential investment to pick up, although uncertainty about fiscal support for green investments and measures to reduce energy costs for firms will continue to weigh on business investment. However, previously accumulated large corporate cash buffers and the investment needs due to supply chains realignment, digitalisation and green transformation will partly offset these negative effects. Export growth will strengthen in 2025, as key export markets recover due to the projected easing of global financial conditions. With restrictive fiscal policy, headline inflation will converge to 2% by the end of 2025, but core inflation will prove sticky, reflecting the impact of wage gains amidst skilled labour shortages.

A prolonged period of policy uncertainty related to the financing of support measures for firms and workers during the green transition could hamper consumer and investor confidence and hold back business investment and private consumption growth. An escalation of tensions in the Middle East could result in more supply chain disruptions, reducing industrial production and exports. On the upside, a stronger recovery in China could significantly improve exports of investment and other goods.

Advancing the green and digital transitions requires more investment

To expand renewable energy supply and raise energy security, it is crucial to continue shortening the time needed for complex planning and approval procedures for infrastructure investments at the municipal and Länder levels. Speeding up digitalisation will require more investment in digital infrastructure and a more rapid modernisation of the public sector, including by setting mandatory common IT standards and encouraging the harmonisation of administrative procedures across levels of government. Skilled labour shortages are also a major barrier for investments. Shifting the tax burden away from labour towards capital income and wealth, for example by reducing generous inheritance tax exemptions for business assets and capital income tax exemptions for investments in existing buildings, would help improve labour supply incentives. This should include reforming the current joint income taxation and health insurance of couples, which lead to very steep marginal income tax rates for second earners and result in more than half of all working women working in part-time jobs for which they are over-qualified. Reducing incentives for early retirement would improve labour supply incentives for older workers and help to stabilise pension spending amidst rising fiscal pressures due to ageing. Implementing plans for a centralised and transparent e‑procurement platform for tenders from all levels of government and encouraging joint procurement initiatives of municipalities through financial incentives would raise spending efficiency and help to ensure fiscal sustainability.