Following a severe recession in the first half of this year, the German economy is likely to recover again. According to current Bundesbank projections, economic output will contract by 7% in 2020, yet in 2021 and 2022, real gross domestic product (GDP) could then increase by 3 and 4% per year, respectively. “Public finances are making a significant contribution to stabilisation,” said Bundesbank President Jens Weidmann with regard to the fiscal stimulus packages and automatic stabilisers. The Federal Government’s latest economic stimulus programme was agreed after the projection was finalised and is therefore not yet included in the estimates. Weidmann welcomed the programme, noting that “Further stimulus is appropriate in the current situation.” This means, in his view, that the economic outlook will now be noticeably more favourable.

As a result of the pandemic and the measures taken to contain it, German economic output already saw an exceptionally sharp drop in the first quarter of 2020. According to the report, another and overall even greater decline is expected for the second quarter. Yet the Bundesbank experts note that the economy already bottomed out in April and is now starting to grow again. “However, there is still a very high degree of uncertainty about what lies ahead for the economy,” Mr Weidmann stressed. This is particularly true with regard to the course of the pandemic, the measures that may be necessary to contain it and the resulting economic repercussions, according to the projection published by the Bundesbank. As the negative effects caused by the pandemic and the measures taken to combat it will likely diminish only gradually, the recovery will initially drag on. The calculations assume that an effective medical solution to the pandemic will become available in mid-2021. This would then provide an additional boost to the German economy. Economic activity would subsequently return to its pre-crisis level at the end of 2022. 
 
The crisis is also impacting the labour market. Despite a massive expansion of short-time work, unemployment is expected to pick up temporarily. The experts say that the comprehensive package of economic policy support measures can prevent significant lasting damage to the goods and labour markets. According to estimates, a stronger economic recovery starting from mid-2021 is likely to see unemployment go back down. 

Effects of stabilisation in the government budget

Given the large fiscal stabilisation contribution, the government deficit and debt will go up significantly. According to the Bundesbank’s projection, the government budget deficit for this year will be 6% of GDP and the debt ratio around 75%. As the economy recovers and assistance measures come to an end, the forecasters expect government finances to improve over the next two years. They see the deficit ratio as being significantly lower again in 2022. The debt ratio will also decline somewhat, but will still be well above its pre-crisis level of around 60%.

According to estimates, the rise in consumer prices is likely to ease considerably this year, amounting to just 0.8%. However, inflation is projected to go back up to 1.1% in 2021 and 1.6% in 2022. According to the experts, energy prices, which are down compared with 2019 as a result of the recent slump in oil prices this year, are the main factor behind this development. By contrast, the core rate excluding energy and food has remained comparatively stable, as the price-increasing effects of the pandemic are partly counteracting the downward pressure from the drop in demand.

Alternative scenarios

In order to take account of the currently very high level of uncertainty, two alternative scenarios have been developed: In addition to the baseline scenario to which the aforementioned projection figures refer and which the Bundesbank considered most likely when finalising the projection, a less severe and a more severe scenario are also examined with regard to the economic consequences of the pandemic. 

In a less severe scenario, the Bundesbank assumes that the easing of the containment measures will already have a stronger positive impact in the short term and that households and enterprises will be much better able to adapt their behaviour to the constraints imposed by the pandemic. This could be facilitated by a timely, marked improvement in the framework conditions, for example through advances in medical research. The negative economic effects of the pandemic would thus recede more rapidly and the economic recovery could be stronger. In this scenario, real GDP will go down by just over 3% this year before rising by 6% in 2021 and 2% in 2022. 

If the expected adjustment processes by economic agents in the baseline scenario are significantly less successful, the economic losses could be considerably greater in a more severe scenario and long-term potential output could take a major hit. In this scenario, Bundesbank estimates show that economic output would contract by as much as 10% this year and 1% next year. Real GDP would rise by 4% in 2022. 

Economic stimulus programme viewed positively

Some of the specifics of the economic stimulus package agreed by the Federal Government only after the projection was completed have yet to be finalised. On the basis of an initial rough estimate by Bundesbank experts, the government deficit could be up by 1½ percent of GDP this year and by ½ percent of GDP next year compared with the projections described above. According to the Bundesbank, the temporary cut in value added tax and the further relief for households and businesses could have a positive impact on consumer and investor sentiment. According to initial estimates, real GDP could be more than 1% higher this year and around ½% higher next year. The growth rates stated in the projections would then be accordingly larger in 2020 and smaller in 2021. Moreover, the value added tax cut, in particular, would have a strong impact on price developments. This is illustrated by a full and immediate pass-through, which would reduce the rate by around one percentage point this year and, mirroring this development, increase it by one percentage point in the coming year. However, the effects were likely to be noticeably smaller, as only a partial pass-through could be assumed. 

Developments in the euro area

This week, the Eurosystem likewise presented its current projections for growth and inflation in the euro area as a whole. According to these, the experts from the European Central Bank (ECB) and the national central banks expect GDP to slump by 8.7% in 2020. They see it rising by 5.2% in 2021 and 3.3% in 2022. With regard to the rate of inflation, the Eurosystem’s experts are expecting that euro area inflation will probably stand at around 0.3% in 2020. It is likely to rise to 0.8% in 2021 and to 1.3% in 2022.

Projection June 2020

Source: Federal Statistical Office. 2020 to 2022 Bundesbank projections.