Germany’s economy needs a fiscal boost
Berlin must loosen the purse strings to avoid the economy tipping into recession
The German economy is stuck in a rut. The country’s large, export-dependent manufacturing sector is reeling from the collapse in global trade while problems within domestic industry compound the overall economic malaise. The services sector has held up, but the disconnect is not certain to last much longer — business cycle indicators already point to a mild recession. Benefits from further monetary easing will be constrained by unprofitable banks and vast savings. Fiscal space is abundant. It must finally be used.
The fall in manufacturing is global, driven by the US-China trade war and China’s maturing and less rapidly growing economy. But this external weakness compounds domestic difficulties in Germany. Disruption in the auto and chemicals industries last year meant the economy only narrowly avoided an outright recession. And while these problems have eased, weakness in industrial output has deepened in recent months.
The third quarter got off to a particularly bad start for manufacturing. July’s purchasing managers’ index collapsed to a seven-year low. The drop in export orders — the main driver of the decline — was the worst for a decade.
Continuing expansion in the service sector has so far provided some relief. Job creation and modest wage gains have helped support domestic demand while the construction sector has held up thanks to housing investment. But the rate of expansion in services is now slowing and business optimism in the sector recently dropped to its lowest in more than four years. Activity in the construction sector also dropped for the first time in nine months.
Manufacturing weakness is spilling over into the labour market. Hiring intentions in the private sector are at a six-year low and employers are starting to cut working hours to reduce wage costs. Announcements of forthcoming redundancies — BASF, Thyssenkrupp and Bayer, among others — alongside a stream of profit warnings from blue-chips, adds to the negative outlook.
Policy options are limited. Expected easing by the European Central Bank next month — taking interest rates deeper into negative territory and a possible resumption of the asset purchase programme — is unlikely to provide the needed stimulus for Germany. Looser monetary policy may help the export sector by keeping a lid on any appreciation of the euro, but it is a blunt tool to offset a manufacturing recession. Even lower borrowing rates may not be passed on due to weak profitability in the banking sector. There is also a reluctance to penalise tax savers with negative deposit rates. That German bond yields are now in negative territory across all maturities leaves banks with no obvious profitable alternatives for their excess liquidity.
Fiscal easing is the only viable option. At close to 60 per cent of gross domestic product public debt is significantly below others in the eurozone, while the budget surplus reached a peak last year. The headline surplus will shrink this year with slower growth but the cyclical fiscal stance must also be eased. Tax cuts and greater spending on public infrastructure are all long overdue.
Next week’s GDP release is expected to confirm the German economy was stagnant in the three months to June. This will be a poor performance compared with the 0.5 per cent expansion in Spain and 0.2 per cent in France. Projections from the European Commission see German growth at just 0.5 per cent this year, slower only than in Italy.
A call for Germany to loosen its purse strings is not new. But it is increasingly urgent. Avoiding a full-blown recession in the world’s fourth-largest economy would benefit far outside the eurozone.