On July 14, 2014, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Germany.

A recovery is under way, led by domestic demand and underpinned by healthy corporate and household balance sheets, a strong labor market, a much improved fiscal position, and accommodative financial conditions. As growth returned in mid-2013, the unemployment rate reached a post-unification low, while the labor force continues to expand on the back of strong immigration and increasing participation. Headline inflation has been on a downward trend reflecting falling import prices and contained wage pressures, but core inflation has been stable around 1.2 percent. The fiscal stance in 2013 was contractionary and fiscal consolidation has put the debt-to-GDP ratio firmly on a downward path. The current account surplus reached a new high in 2013, as lower surpluses vis-à-vis the euro area periphery were offset by larger ones vis-à-vis economies outside of Europe. While credit conditions remain favorable, credit growth has been lackluster, reflecting low demand despite the upturn in the housing market.

The German banking system is downsizing and gradually strengthening. While profitability remains subdued and under pressure from persistently low interest rates, improvements in capital adequacy continued, as banks prepared to meet upcoming stricter regulatory requirements and the ECB Comprehensive Assessment got under way.

The short-term outlook is for GDP growth to gain momentum. As domestic demand growth becomes more broad-based, output should increase by 1.9 percent this year and 1.7 percent the next, and the current account surplus should begin to decline gradually. Inflation should pick up and remain above that in the rest of the euro area as the residual slack in the economy is eliminated. Growth in the medium term, however, is expected to remain constrained by the still weak and precarious international environment, lingering uncertainty (including about future energy costs), and fast approaching adverse demographic developments.

Executive Board Assessment²

Executive Directors broadly commended the German authorities for their continued prudence in macroeconomic policies and commitment to a strengthened European integration. Directors concurred that Germany has strong fundamentals, notably the generally healthy balance sheets, strong fiscal position, and historically low unemployment. These, together with accommodative financial conditions and a robust labor market, have underpinned the economic recovery. Directors observed, nevertheless, that medium-term growth prospects remain subdued against a still weak international environment, lingering uncertainty about future energy costs, and looming demographic changes. Accordingly, they emphasized the importance of growth-enhancing policies, which would also generate positive spillovers to the rest of the euro area, preserving the role of the German economy as an anchor of regional stability.

Directors considered that policies that focus on strengthening domestic sources of growth, promoting private investment, and reducing the current account surplus would be beneficial for both Germany and the euro area as a whole, while also facilitating external rebalancing. To this end, most Directors recommended that the authorities use available space to boost public investment in projects with true economic value, especially in transport infrastructure and education, while adhering to the European and national fiscal rules. Noting that the economy is operating at close to its potential in the presence of downside risks and uncertainty, a few Directors stressed the need to maintain a safety margin and confidence in public finances.

Directors welcomed ongoing reform initiatives to increase competition in product markets and address remaining challenges in the energy sector. They noted that greater clarity about energy prices and the regulatory framework would encourage private investment in renewable energy production and infrastructure more broadly, positively contributing to growth and regional spillovers. Directors also encouraged further efforts to improve productivity and reduce barriers to competition in the services sector, especially professional services.

Directors acknowledged the remarkable success in achieving low unemployment and continued efforts to promote social equality and fairness. They urged the authorities to implement a new national minimum wage with care, mindful of its potential adverse effects on employment across regions and economic sectors. At the same time, they encouraged exploring well-targeted measures to achieve income redistribution while raising labor market participation and minimizing fiscal costs. Directors advised that these considerations be taken into account in future decisions on the minimum wage and reviews of the new pension law.

Directors noted the overall strength of German banks and encouraged proactive efforts to further build up capital buffers ahead of the Comprehensive Assessment by the European Central Bank. They also emphasized the importance of robust domestic supervision in the transition to the Single Supervisory Mechanism, and close coordination among all supervisory bodies. Directors looked forward to continued progress in implementing the FSAP recommendations and to Germany’s leadership in advancing a banking union.

Directors highlighted the need to remain vigilant to developments in the housing market and insurance sector as monetary conditions are likely to remain accommodative for a prolonged period. In this regard, they welcomed steps to make the new Financial Stability Committee fully operational, and supported enhancing the macroprudential toolkit. Directors were also reassured by the authorities’ intention to take appropriate policy action to address vulnerabilities in the insurance sector.