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Should the alleviation of uncertainty and an expected gradual recovery in the rest of the euro area fail to materialise, growth can be expected to remain below its potential for longer, leading to a widening of the output gap which would eventually result in slack in the labour market. Another important source of risk is a rise in financial stress in the region, which could interact with already weak demand and uncertainty, to amplify the impact on the German economy through both trade and financial channels. These risks could be further compounded by weaker global growth prospects. A more medium-term risk is that of an extended period of low growth, which could result in a reduction of the economy’s growth potential.
The marginal loosening of the fiscal stance this year is appropriate. Germany has already achieved the deficit goals at the federal level under the national debt brake rule (Schuldenbremse) well ahead of schedule and the general government balance is in line with the commitments of the Fiscal Compact of the Economic and Monetary Union (EMU). For 2013, the IMF projects a mildly expansionary fiscal stance which it sees as appropriate given the small output gap and the risks to the outlook. From 2014 onwards, the IMF projects only modest structural consolidation, which is broadly consistent with a neutral fiscal stance while ensuring that public debt remains on a firmly declining path.
Given the weak growth environment and significant risks to the outlook, it will be important to avoid over performing on consolidation. Over the past three years, the fiscal balance has exceeded plans, reflecting in part unusual factors such as the greater-than-expected strength in labour markets and the low interest rate environment. With the labour market adjustments expected to have run their course, fiscal over-performance due to these factors is unlikely. Nevertheless, fiscal over performance should be firmly avoided as it could imply a contractionary fiscal stance that is unwarranted in the current low growth environment.
The financial reform momentum should be sustained both domestically and at the regional level. At the domestic level, further augmenting capital buffers, improving profitability and efficiency, and adjusting business models ahead of new international and European regulatory requirements would help consolidate financial strength. The surveillance of large cross-border banks needs to be firmly anchored by strong domestic supervision and close coordination with key financial centers' supervisory authorities. A clear, harmonised, and coherent roadmap towards achieving domestic and European initiatives, including steps towards reversing the fragmentation of banking systems across Europe and creating an integrated pan-European banking system, would help alleviate a major question mark over the European financial system.
Germany’s strong fundamentals provide an anchor of stability to the region. Germany’s safe haven status and strong balance sheets provide a buffer against external shocks for the region. Germany also plays a pivotal role in the development of policies and the evolving architecture of the EMU. Given the important role of euro area uncertainty and external demand for German growth, the IMF welcomes Germany’s continued leadership towards further integration within the EMU. Germany can also play an important role in clearly articulating the longer-term shared vision for closer economic and financial integration among EMU member countries, which would provide a crucial anchor to the expectations of households, firms, and the financial system.