Europe’s largest economy is Germany and the prospects and growth figures of this country are crucial to the growth of the Eurozone as a whole. The EU is a key trading partner for the UK and hence the growth data of Germany and in turn of the Eurozone is also essential in creating buoyant economic conditions within our borders. The bad news is that the economic growth forecast for Germany has been cut by the German government.
The German government had previously estimated that the growth rate for this year would be 1.8%, but the estimate has now been revised down to 1.2% and next year’s growth rate has also been revised downwards from 2% to 1.3%. Clearly the expectation is that low growth is set to continue.
Whenever there are changes in macroeconomic variables, a key question is always about the cause of such change, for example is inflation caused by demand-pull or cost-push factors. The German government has been quick to state that the lower growth rates are not due to internal factors, but have been affected by external factors, in particular the state of the global economy. As such, there are no plans to make significant changes to domestic policy, as the domestic economy remains in a strong position. The economy Minister said:
“The German economy finds itself in difficult external waters … Domestic economic forces remain intact, with the robust labour market forming the foundation … As soon as the international environment improves, the competitiveness of German companies will bear fruit and the German economy will return to a path of solid growth … [for this reason there is] no reason to abandon or change our economic or fiscal policy.”
The global picture remains relatively weak and while some economies, including the UK, have seen growth pick up and unemployment fall, there are concerns that the economic recovery is beginning to slow. With an increasingly interdependent world, the slowing down of one economy can have a significant impact on the growth rate of others. If country A begins to slow, demand for imports will fall and this means a fall in the demand for exports of country B. For countries that are dependent on exports, such as Germany and China, a fall in the demand for exports can mean a big decline in aggregate demand and in August, Germany saw a 5.8% drop in exports.
Adding to the gloom is data on inflation, suggesting that some other key economies have seen falls in the rate of inflation, including China. The possibility of a triple-dip recession for the Eurozone has now been suggested and with its largest economy beginning to struggle, this suggestion may become more real. The following articles consider the macroeconomic picture.
Articles
Germany cuts growth forecasts amid recession fears, as Ireland unveils budget The Guardian, Graeme Wearden (14/10/14)
As cracks in its economy widen, is Germany’s miracle about to fade? The Observer, Philip Oltermann (19/10/14)
Why the German economy is in a rut The Economist (21/10/14)
Germany’s flagging economy: Build some bridges and roads, Mrs Merkel The Economist (18/10/14)
Germany cuts 2014 growth forecast from 1.8% to 1.2% BBC News (14/10/14)
IMF to cut growth forecast for Germany – der Spiegel Reuters (5/10/14)
Fears of triple-dip eurozone recession, as Germany cuts growth forecast The Guardian, Phillip Inman (15/10/14)
Germany slashes its economic forecasts Financial Times, Stefan Wagstyl (14/10/14)
Merkel vows austerity even as growth projection cut Bloomberg, Brian Parkin, Rainer Buergin and Patrick Donahue (14/10/14)
Is Europe’s economic motor finally stalling? BBC News, Damien McGuinness (17/10/14)
Why Germany won’t fight deflation BBC News, Robert Peston (16/10/14)
Data
World Economic Outlook Database IMF (15/10/14)
World Economic Outlook IMF (October 2014)
Questions
- How do we measure economic growth and is it a good indicator of the state of an economy?
- What are the key external factors identified by the Germany government as the reasons behind the decline in economic growth?
- Angela Merkel has said that austerity measures will continue to balance the budget. Is this a sensible strategy given the revised growth figures?
- Why is low inflation in other economies further bad news for those countries that have seen a decline or a slowdown in their growth figures?
- Why is interdependence between nations both a good and a bad thing?
- Using AS and AD analysis, illustrate the reasons behind the decline German growth. Based on your analysis, what might be expected to happen to some of the other key macroeconomic variables in Germany and in other Eurozone economies?
In two posts recently, we considered the pessimistic views of Robert Peston about the prospects for the global economy (see Cloudy skies ahead? and The end of growth in the West?). In this post we consider the views of Christine Lagarde, Managing Director of the International Monetary Fund, and Lord Adair Turner, the former head of the Financial Services Authority (FSA) (which was replaced in 2013 by the Financial Conduct Authority and the Prudential Regulation Authority).
Christine Lagarde was addressing an audience at Georgetown University in Washington DC. The first four links below are to webcasts of the full speech and subsequent interviews about the speech. She gives a more gloomy assessment of the global economy than six months ago, especially the eurozone economy and several emerging economies, such as China. There are short- to medium-term dangers for the world economy from political conflicts, such as that between Russia and the West over Ukraine. But there are long-term dangers too. These come from the effects of subdued private investment and low infrastructure spending by governments.
Her views are backed up by the six-monthly World Economic Outlook, published by the IMF on 7 October. There are links below to two webcasts from the IMF discussing the report and the accompanying datasets.
In the final webcast link below, Lord Turner argues that there is a “real danger of a simultaneous slowdown producing a big setback to growth expectations.” He is particularly worried about China, which is experiencing an asset price bubble and slowing economic growth. Other emerging economies too are suffering from slowing growth. This poses real problems for developed countries, such as Germany, which are heavily reliant on their export sector.
Webcasts
The Challenges Facing the Global Economy: New Momentum to Overcome a New Mediocre IMF Videos, Christine Lagarde (full speech) (2/10/14)
Christine Lagarde downbeat on global economy BBC News Canada, Christine Lagarde interviewed by Katy Kay (2/10/14)
IMF’s Lagarde on Global Economy, Central Banks Bloomberg TV, Christine Lagarde interviewed by Tom Keene (2/10/14)
Lagarde: Global economy weaker than envisioned 6 months ago, IMF to cut growth outlook CNBC (2/10/14)
IMF Says Uneven Global Growth Disappoints IMF Videos, Olivier Blanchard (7/10/14)
Time Is Right for an Infrastructure Push IMF Videos, Abdul Ablad (30/9/14)
China slowdown poses ‘biggest risk to global economy’ The Telegraph, Adair Turner (4/10/14)
Articles
Global Growth Disappoints, Pace of Recovery Uneven and Country-Specific IMF Survey Magazine (7/10/14)
Global economy risks becoming stuck in low growth trap The Telegraph, Szu Ping Chan (2/10/14)
American Exceptionalism Thrives Amid Struggling Global Economy Bloomberg, Rich Miller and Simon Kennedy (4/10/14)
World Bank cuts China growth forecast for next three years BBC News (6/10/14)
Beware a Chinese slowdown The Guardian, Kenneth Rogoff (6/10/14)
IMF says economic growth may never return to pre-crisis levels The Guardian, Larry Elliott (7/10/14)
IMF goes back to the future with gloomy talk of secular stagnation The Guardian, Larry Elliott (7/10/14)
Data
World Economic Outlook Database IMF (7/10/14)
World Economic Outlook IMF (October 2014)
Questions
- What are the particular ‘headwinds’ facing the global economy?
- Why is the outlook for the global economy more pessimistic now than six months ago?
- Why are increasing levels of debt and asset price rises a threat to Chinese economic growth?
- Why may China be more able to deal with high levels of debt than many other countries?
- In what ways are commodity prices an indicator of the confidence of investors about future economic growth?
- What are the determinants of long-term economic growth? Why are potential economic growth rates lower today than in the 2000s?
- How might governments today boost long-term economic growth?
- What are the arguments for and against governments engaging in large-scale public investment in infrastructure projects? What would be the supply-side and demand-side effects of such policies?
- If confidence is a major determinant of investment, how might bodies such as the IMF boost confidence?
- Why does the IMF caution against over-aggressive attempts to reduce budget deficits?
The latest GDP numbers from the Office for National Statistics contained in Quarterly National Accounts, Q2 2014 show the economy’s output expanded by 0.9 per cent in the second quarter. This follows on the back of a 0.7 per cent increase in output in Q1 2014. The economy’s output is now thought to be 0.7 per cent above its Q1 2008 peak. Yet, the data show very different profiles for the four principal industrial sectors. The service sector appears to be ploughing ahead while the rest (production, construction and agriculture) lag behind.
Chart 1 shows quarterly economic growth since 1980s (click here for a PowerPoint of the chart). It illustrates nicely the inherent volatility of economies – one of the threshold concepts in economics. The average quarterly rate of growth since 1980 has been 0.5 per cent. On the face of it, a quarterly growth number of 0.9 per cent would appear very robust. Of course, this has to been set in the context of the 2008/9 recession. UK output peaked in Q1 2008 (£414.424 billion at 2011 prices). The revised data now show that there followed 5 quarters of declining output (previously, data suggested the duration of the recession was 6 quarters). During this period output shrank 6 per cent (GDP at 2011 prices had fallen by Q2 2009 to £389.388 billion ).
Chart 1 highlights two earlier downturns. First, there is the recession of the early 1980s. We can see the 5-quarter recession that commenced in Q1 1980. By the end of this recession output had shrunk by 4.5 per cent. Second, there is the recession of the early 1990s which commenced in Q3 1990. Again, this recession lasted five quarters. By the time the economy had come out of recession it had shrunk 2.2 per cent.
Consider now Chart 2 (click here for a PowerPoint of the chart). It allows us to analyse more recent events by tracking how industrial output has evolved since 2006. It suggests an unbalanced recovery. From it, we observe that in Q2 2014 service-sector output was 6.5 per cent higher than in Q1 2008. However, a very different picture emerges for the other principal industrial types. Output across the production industries remains 9.7 per cent lower, 9.2 per cent lower in agriculture and 8.9 per cent lower in the construction sector.
In short, the British economy continues to struggle to rebalance its industrial base. The business cycle remains heavily dependent on the service sector.
Articles
UK GDP revised up: what the economists say Guardian, Katie Allen (30/9/14)
UK economy grew 0.9% in second quarter, says ONS BBC News, Katie Allen (9/5/14)
UK GDP: Did the UK economy do well after all? Independent, Ben Chu (30/9/14)
UK economy grew 0.9% Herald, Ian McConnell (1/10/14)
Economy tracker: GDP BBC News (30/9/14).
Data
Quarterly National Accounts, Q2 2014 Dataset Office for National StatisticsQuarterly National Accounts, Q2 2014, Statistical Release Office for National Statistics
Questions
- What is the difference between nominal and real GDP? Which of these helps to track changes in economic output?
- Looking at Chart 1 above, summarise the key patterns in real GDP since the 1980s.
- What is a recession?
- What are some of the problems with the traditional definition of a recession?
- Can a recession occur if nominal GDP is actually rising? Explain your answer.
- What factors lead to economic growth being so variable?
- What factors might explain the very different patterns seen since the late 2000s in the volume of output of the four main industrial sectors?
- What different interpretations could there be of a ‘rebalancing’ of the UK economy?
- What other data might we look at to analyse whether the UK economy is ‘rebalancing’?.
- Produce a short briefing paper exploring the prospects for economic growth in the UK over the next 12 to 18 months.
- What is the difference between GVA and GDP?
- Explain the arguments for and against using GDP as a measure of a country’s economic well-being.
The French economy is flatlining. It has just recorded the second quarter of zero economic growth, with growth averaging just 0.02% over the past 12 months. What is more, the budget deficit is rising, not falling. In April this year, the French finance minister said that the deficit would fall from 4.3% in 2013 to 3.8% in 2014 and to the eurozone ceiling of 3% in 2015. He is now predicting that it will rise this year to 4.4% and not reach the 3% target until 2017.
The deficit is rising because a flatlining economy is not generating sufficient tax revenues. What is more, expenditure on unemployment benefits and other social protection is rising as unemployment has risen, now standing at a record 10.3%.
And it is not just the current economic situation that is poor; the outlook is poor too. The confidence of French companies is low and falling, and investment plans are muted. President Hollande has pledged to cut payroll taxes to help firms, but so far this has not encouraged firms to invest more.
So what can the French government do? And what can the EU as a whole do to help revive not just the French economy but most of the rest of the eurozone, which is also suffering from zero, or near zero, growth?
There are two quite different sets of remedies being proposed.
The first comes from the German government and increasingly from the French government too. This is to stick to the austerity plans: to get the deficit down; to reduce the size of government in order to prevent crowding out; and to institute market-orientated supply-side policies that are business friendly, such as reducing business regulation. Business leaders in France, who generally back this approach, have called for reducing the number of public holidays and scrapping the maximum 35-hour working week. They are also seeking reduced business taxes, financed by reducing various benefits.
Increasingly President Hollande is moving towards a more business-friendly set of policies. Under his government’s ‘Responsibility Pact’, a €40 billion package of tax breaks for business will be financed through €50 billion of cuts in public spending. To carry through these policies he has appointed an ex-investment banker, Emmanuel Macron, as economy minister. He replaces Arnaud Montebourg, who roundly criticised government austerity policy and called for policies to boost aggregate demand.
This brings us to the alternative set of remedies. These focus on stimulating aggregate demand through greater infrastructure investment and cutting taxes more generally (not just for business). The central argument is that growth must come first and that this will then generate the tax revenues and reductions in unemployment that will then allow the deficit to be brought down. Only when economic growth is firmly established should measures be taken to cut government expenditure in an attempt to reduce the structural deficit.
There are also compromise policies being proposed from the centre. These include measures to stimulate aggregate demand, mainly through tax cuts, accompanied by supply-side policies, whether market orientated or interventionist.
As Europe continues to struggle to achieve recovery, so the debate is getting harsher. Monetary policy alone may not be sufficient to bring recovery. Although the ECB has taken a number of measures to stimulate demand, so far they have been to little avail. As long as business confidence remains low, making increased liquidity available to banks at interest rates close to zero will not make banks more willing to lend to business, or businesses more willing to borrow. Calls for an end, or at least a temporary halt, to austerity are thus getting louder. At the same time, calls for sticking to austerity and tackling excessive government spending are also getting louder.
Articles
Hollande entrusts French economy to ex-banker Macron Reuters, Ingrid Melander and Jean-Baptiste Vey (26/8/14)
France’s new Minister of the Economy Emmanuel Macron described by left-wingers as a ‘copy-and-paste Tony Blair’ Independent, John Lichfield (28/8/14)
Merkel praises France’s economic reform plans after Berlin talks with PM Valls Deutsche Welle (22/9/14)
French economy flat-lines as business activity falters Reuters, Leigh Thomas (23/9/14)
French public finances: Rétropédalage The Economist (13/9/14)
French employer group urges ‘shock therapy’ for economy Reuters (24/9/14)
Last chance to save France: loosen 35-hour week and cut public holidays, say bosses The Telegraph (24/9/14)
‘Sick’ France’s economy is stricken by unemployment ‘fever’ The Telegraph (17/9/14)
France’s economics ills worsen but all remedies appear unpalatable The Observer, Larry Elliott and Anne Penketh (31/8/14)
The Fall of France The New York Times, Paul Krugman (28/8/14)
Why Europe is terrified of deflation Salon, Paul Ames (20/9/14)
Europe’s Greater Depression is worse than the 1930s The Washington Post, Matt O’Brien (14/8/14)
Worse than the 1930s: Europe’s recession is really a depression The Washington Post, Matt O’Brien (20/8/14)
Eurozone business growth slows in September, PMI survey finds BBC News (23/9/14)
Europe must ‘boost demand’ to revive economy, US warns BBC News (21/9/14)
Valls says France would never ask Germany to solve its problems Reuters, Annika Breidthardt and Michelle Martin (23/9/14)
The euro-zone economy: Asset-backed indolence The Economist (11/9/14)
Data
Annual macro-economic database (AMECO) Economic and Financial Affairs DG, European Commission
Business and Consumer Surveys Times Series Economic and Financial Affairs DG, European Commission
StatExtracts OECD
Statistics database European Central Bank
Questions
- What types of supply-side reforms would be consistent with the German government’s vision of solving Europe’s low growth problem?
- How could a Keynesian policy of reflation be consistent with getting France’s deficit down to the 3% of GDP limit as specified in the Stability and Growth Pact (see)?
- What is meant by (a) financial crowding out and (b) resource crowding out? Would reflationary fiscal policy in France lead to either form of crowding out? How would it be affected by the monetary stance of the ECB?
- Give examples of market-orientated and interventionist supply-side policies.
- What is meant by the terms ‘cyclical budget deficit’ and ‘structural budget deficit’. Could demand-side policy affect the structural deficit?
- Using the European Commission’s Business and Consumer Surveys find our what has happened to business and consumer confidence in France over the past few months.
- How important is business and consumer confidence in determining economic growth in (a) the short term and (b) the long term?
The instability of the economy was clearly demonstrated by the events of the late 2000s. Economists have devoted considerable energies to understanding the determinants of the business cycle. Increasing attention is focused on the role that credit cycles play in contributing to or exacerbating cycles. Therefore, data on lending by banks is followed keenly by policymakers who wish to avoid the repeat of the pace of growth in credit seen in the period preceding the financial crisis. Interestingly, the latest data from the Bank of England show that lending by financial institutions to households (net of repayments) rose in July to its highest level since November 2009.
The idea of credit cycles is not new. But, the financial crisis of the late 2000s has helped to reignite analysis and interest. Many economists have revisited the work of Hyman Minsky (1919–1996), an American economist, who argued that financial cycles are an inherent part of the economic cycle and contribute to fluctuations in real GDP. Notably, he argued that credit extended to households and businesses is pro-cyclical so that flows of credit extended by banks are larger when the growth of the economy’s output is stronger. Since credit flows are dependent on the phase of the business cycle, they are said to be endogenous to the path of output. The key point here is that there is an inherent mechanism within the economy which is potentially destabilising.
Banks, it is argued, may use the growth of the economy’s output as an indicator of the riskiness of its lending. Households and businesses may undertake a similar assessment. After a period of sustained growth banks and investors become more confident about the future path of the economy and, consequently, in the returns of assets. This means that there is a role for psychology in understanding the business cycle.
If we look at the chart, this period of heightened confidence may correspond with the period starting from the late 1990s. Between 1998 and 2007 the average monthly net flow of credit to private non-financial corporations and households was £9.4 billion. In other words, households and businesses were acquiring a staggering £9.4 billion of additional debt from banks each month. But, this was as high as £14.0 billion per month in 2007. (Click here for a PowerPoint of the chart.)
What helped to fuel the impact of heightened confidence on credit provision was financial innovation. In particular, the bundling of assets, such as mortgages, to form financial instruments which could then be purchased by investors helped to provide financial institutions with further funds for lending. This is the process of securitisation. The result was that during the 2000s as households and businesses began to acquire larger debts their financial well-being became increasingly stretched. This was hastened by central banks raising interest rates. The intention was to dampen the rising rate of inflation, partly attributable to rising global commodity prices, such as oil. Suddenly, euphoria was replaced with pessimism.
Some argue that a Minsky moment had occurred. Many countries then witnessed a balance sheet recession. As individual households and businesses try and improve their own financial well-being they collectively contribute to its worsening. For instance, large-scale attempts to sell assets, such as shares or property, only help to cause their value to decline.
A global response to the events of the financial crisis has been for policy-makers to pay more attention to the aggregate level of credit provision. The chart shows that lending in 2014 is more robust than it has been form some time. Across the first seven months of 2014 the average monthly net flow of credit extended by banks to households and businesses (private non-financial corporations) has been £2.2 billion.
However, the 2014-rebound of credit is wholly attributable to lending to households. Net lending to households has averaged £2.7 billion per month while businesses have been repaying credit to banks to the tune of £437 million per month – something that businesses have collectively done in each year from 2009. While net lending to households remains considerably lower than pre-financial crisis levels, it will be something that policymakers will be watching very closely. This, in turn, means that they will be paying particular interest to the housing and mortgage markets.
Articles
Appetite for loans picks up again, say major banks BBC News (23/9/14)
Business lending by UK banks is down by £941m Herald Scotland, Ian McConnell (27/8/14)
How bank lending fell by £365 BILLION in five years… much to the delight of controversial payday loan firms Mail, Louise Eccles (7/09/14)
U.K.’s Big Banks Cut Lending by $595 Billion, KPMG Says Bloomberg, Richard Partington (8/9/14)
UK banks’ home loan approvals fall to 12-month low – BBA Reuters, Andy Bruce and Tom Heneghan (23/9/14)
Data
Bankstats (Monetary and Financial Statistics) – Latest Tables Bank of England
Statistical Interactive Database Bank of England
Questions
- What is meant by the term the business cycle?
- What does it mean for the determinants of the business cycle to be endogenous? What about if they are exogenous?
- Outline the ways in which the financial system can impact on the spending behaviour of households. Repeat the exercise for businesses.
- How might uncertainty affect spending and saving by households and businesses?
- What does it mean if bank lending is pro-cyclical?
- Why might lending be pro-cyclical?
- How might the differential between borrowing and saving interest rates vary over the business cycle?
- Explain what you understand by net lending to households or firms. How does net lending affect their stock of debt?
Europe’s largest economy is Germany and the prospects and growth figures of this country are crucial to the growth of the Eurozone as a whole. The EU is a key trading partner for the UK and hence the growth data of Germany and in turn of the Eurozone is also essential in creating buoyant economic conditions within our borders. The bad news is that the economic growth forecast for Germany has been cut by the German government.
