In the Blog, A VW recession for the eurozone, as German growth revised down?, we discussed the pessimistic outlook for the eurozone, in part driven by the problems facing the engine of Europe: Germany. While the German government noted that the weak growth figures are due to external factors, it appears as though these external factors are now sending waves through the domestic economy.
Over the past 6 months, German confidence has fallen continuously and now stands at almost its lowest level in 2 years. Think tank data from a survey of 7000 firms in Germany fell from 104.7 to 103.2 for October – the weakest reading since December 2012. Confidence is always a key factor in the strength of an economy, as it affects consumers and businesses. 
Without consumer and business confidence, two key components of aggregate demand are weak and this downward pressure on total spending in the economy depresses economic growth. An economist from Ifo, the think-tank that produced this business climate index, said that firms felt ‘downbeat about both their current situation and the future.’
As confidence continues to decline in Germany, the economic situation is unlikely to improve. Unfortunately, it is something of a vicious circle in that without economic growth confidence won’t return and without confidence, economic growth won’t improve. The industrial sector is crucial to Germany and the data is concerning, according to Chief economist at Commerzbank, Joerg Kraemer:
The latest numbers from the industrial sector are very worrisome…The third quarter was probably worse than expected, the economy may have stagnated at best.
Numerous factors continue to depress the German economy and while negative growth is not expected, estimates for quarterly growth from July to September remain at around 0.3%. As Europe’s largest economy, such low growth rates will be of concern to the rest of the Eurozone and may also bring worry to other countries, such as the US and UK. With growing interdependence between nations, the success of countries such as Germany and Europe as a whole influences the economic situation abroad. Commentators will be looking for any signal that Germany is strengthening in the coming months and an improvement in business confidence will be essential for any prolonged recovery.
German business confidence falters again in October Wall Street Journal, Todd Buell (27/10/14)
German business morale weakens to lowest level in almost two years Reuters, Michelle Martin (27/10/14)
Zero growth best hope for Germany as confidence disappears The Telegraph, Szu Ping Chan (27/10/14)
German Ifo business confidence drops for sixth month Bloomberg, Stefan Riecher (27/10/14)
German business confidence plunges again as analysts urge fiscal stimulus International Business Times, Finnbarr Bermingham (27/10/14)
German business confidence falls again, Ifo says BBC News (27/10/14)
German business confidence tumbles The Guardian, Philip Inman (24/9/14)
The German way of stagnating BBC News, Robert Peston (11/11/14)
Questions
- Why is consumer and business confidence such an important element in explaining the state of an economy?
- Use an AD/AS diagram to illustrate the impact on national output of a decline business confidence. What are the other consequences for the macroeconomic objectives?
- What actions can a government take to boost confidence in an economy?
- If economic growth is weak and confidence is low, is there any point in cutting interest rates as a means of stimulating investment?
- If the eurozone did move back into recession, what could be the possible consequences for countries such as the UK and US?
- How useful are indices that measure business confidence?
Following the financial crisis, all sectors of the economy continue to repair their balance sheets. As well as households, non-financial corporations and government, this is true of the banking sector. In part, the repairing and rebalancing of their balance sheets is being brought about by regulatory pressures. The objective is to make banks more resilient to shocks and less susceptible to financial distress.
The need for banks to repair and rebalance their balance sheets is significant because of their systemic importance to the modern-day economy. Financial institutions that are systemically important to national economies are know as SIFIs (systemically important financial institutions) while those of systemic importance to the global economy are know as G-SIFIs or G-SIBs (global systemically important banks). The increasing importance of financial institutions to economic activity is known as financialisation.
One way of measuring the degree of financialisation here in the UK is to consider the aggregate size of the balance sheet of resident UK banks and building societies (including foreign subsidiaries operating here). The chart shows that the balance sheet grew from £2.6 trillion in 1998 Q1 to £8.5 trillion in 2010 Q1. Another way of looking at this is to consider this growth relative to GDP. This reveals that the aggregate balance sheet of banks and building societies grew over this period from 3 times annual GDP to a staggering 5.6 times GDP. (Click here for a PowerPoint of the chart.)
But, now consider the aggregate banking balance sheet in the 2010s. This reveals a shrinking balance sheet. At the end of the second quarter of this year (2014 Q2) it had fallen back to £7.1 trillion or 4 times GDP. As a share of GDP, this was the smallest the aggregate balance sheet had been since 2005 Q1.
Does a shrinking balance sheet matter? This is where the analysis becomes tricky and open to debate. If the smaller size is consistent with a more stable financial system then undoubtedly that is a good thing. But, size is not that all matters. The composition of the balance sheet matters too. This requires an analysis of, among other things, the liquidity of assets (i.e. assets that can be readily turned in a given amount of cash), the reliability of the income flow from assets and the resources available to withstand periods of slow economic growth, including recessions, or periods of financial difficulty.
As we have identified before (see Financialisation: Banks and the economy after the crisis), the financial crisis could herald new norms for the banking system with important implications for the economy. If so, we may need to become accustomed to consistently lower flows of credit and not to the levels that we saw prior to the financial crisis of the late 2000s. However, an alternative view is that we are merely experiencing a pause before the next expansionary phase of the credit cycle. This is consistent with the financial instability hypothesis (see Keeping a Minsky-eye on credit) which argues that credit cycles are an integral part of modern financialised economies. Only time will tell which view will turn out to be right.
Articles
‘Cleaning up bank balance sheets is key’ Irish Examiner, John Walsh (10/10/14)
More action needed at European banks: Fitch Courier Mail, (17/10/14)
Bank lending to small businesses falls by £400m The Telegraph, Rebecca Burn-Callander (20/10/14)
Bank lending to SMEs falls by £400m SME insider, Lindsey Kennedy (21/10/14)
Record world debt could trigger new financial crisis, Geneva report warns The Guardian, Phillip Inman (29/10/14)
RBS shares jump as bank’s bad debts improve The Guardian, Jill Treanor (30/10/14)
Data
Statistical Interactive Database Bank of England
Questions
- Using examples, demonstrate your understanding of financialisation.
- Draw up a list of the alternative ways in which we might measure financialisation.
- What factors are likely to explain the recent reduction in the aggregate balance sheet of resident banks and building societies in the UK?
- How might we go about assessing whether the aggregate level of lending by financial institutions is sustainable?
- How might we go about assessing whether the level of lending by individual financial institutions is sustainable?
- How would reduced flows of credit be expected to impact on the economy both in the short term and in the longer term?
- Are credit cycles inevitable?
- Of what significance are credit cycles in explaining the business cycle?
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?
Now here’s a gloomy article from Robert Peston. He’s been looking at investors’ views about the coming years and sees a general pessimism about the prospects for long-term economic growth. And that pessimism is becoming deeper.
It is true that both the UK and the USA have recorded reasonable growth rates in recent months and do seem, at least on the surface, to be recovering from recession. But, according to investor behaviour, they:
seem to be saying, in how they place their money, that the UK’s and USA’s current reasonably rapid growth will turn out to be a short-lived period of catch-up, following the deep recession of 2008-9.
So what is it about investor behaviour that implies a deep pessimism and are investors right to be pessimistic? The article explores these issues. It does also look at an alternative explanation that investors may merely be being cautious until a clearer picture emerges about long-term growth prospects – which may turn out to be better that many currently now predict.
The article finishes by looking at a possible solution to the problem (if you regard low or zero growth as a problem). That would be for the government to ‘throw money at investment in infrastructure – to generate both short-term growth and enhance long-term productive potential.’
Note that Elizabeth also looks at this article in her blog The end of growth in the west?.
The end of growth in the West? BBC News, Robert Peston (26/9/14)
Questions
- What is meant by the ’25-year yield curve for government bonds’? Why does this yield curve imply a deep level of business pessimism about the long-term prospects for UK economic growth?
- What are the determinants of long-term economic growth?
- Looking at these determinants, which ones suggest that long-term economic growth may be low?
- Are there any determinants which might suggest that economic growth will be maintained over the long term at historical levels of around 2.6%?
- Do demand-side policies affect potential GDP and, if so, how?
- What policies could government pursue to increase the rate of growth in potential GDP?
- What current ‘dramas’ affecting the world economy could have long-term implications for economic growth? How does uncertainty about the long-term implications for the global economy of such dramas itself affect economic growth?
- Is long-term growth in real GDP an appropriate indicator of (a) economic development and (b) long-term growth in general well-being?
The growth rates of the Western world have been somewhat volatile for the past decade, with negative growth sending economies into recession and then varying degrees of economic recovery. Growth rates elsewhere have been very high, in particular in countries such as China and India. The future of economic growth in the west is hotly debated and whether the western world has been forever changed by the credit crunch remains to be seen.
The article below from the BBC, written by Robert Peston, the Economics Editor, addresses the question of the future of the western world. Opinions differ as to whether the west is finally recovering from the recession and financial instability or if the credit crunch and subsequent recession is just the beginning of many years of economic stagnation. The article in particular focuses on the yield curve and the trends in government debt or gilts. This tends to be a key indicator of the expectations of the future of an economy and how confident investors are in its likely trajectory. Though technical in places, this article provides some interesting stances on what we might expect in the coming 2-3 decades for economic performance in the West.
Note that John also looks at this article in his blog Cloudy Skies Ahead?
The end of growth in the West? BBC News, Robert Peston (26/9/14)
Questions
- Which factors affect the economic growth of a nation?
- Confidence from consumers, firms and investors is always argued to be crucial to the future economic growth and in many cases, the recovery of an economy. Explain why this factor is so important.
- What is the yield curve and what does it show?
- How can the yield curve be used to offer predictions about the future strength of an economy?
- Why are governments seen as the safest place to lend?
- If Larry Summers is correct in saying that it is a negative equilibrium interest rate that is needed to generate full employment growth, what does this suggest about the future economic performance of the western world?
- In the article, there is a list of some of the key things that make investors anxious. Review each of these factors and explain why it is so important in generating anxiety.
In the Blog, A VW recession for the eurozone, as German growth revised down?, we discussed the pessimistic outlook for the eurozone, in part driven by the problems facing the engine of Europe: Germany. While the German government noted that the weak growth figures are due to external factors, it appears as though these external factors are now sending waves through the domestic economy.
