Germany projection note OECD Economic Outlook November 2023 by OECD

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Germany The economy is projected to grow by 0.6% in 2024 and 1.2% in 2025, after contracting slightly in 2023. Decreasing inflation and rising wages will support real incomes and private consumption. High interest rates will weigh on residential investment and damp export demand for investment goods. However, non-residential investment will gradually pick up due to support from high corporate savings and investment needs related to the relocation of supply chains, digitalisation and renewable energy expansion. This will be supported by rising public investment and fiscal incentives for green investments. Exports will slowly recover as global demand strengthens. The decreasing fiscal deficit will help contain inflationary pressures. Improving infrastructure planning, approval processes and implementation capacity, particularly at the municipal level, would accelerate the energy transition and digitalisation. Skilled labour force shortages should be addressed by strengthening the work incentives of women, older workers and low-income earners, improving training and adult learning, and facilitating the recognition of the qualifications of migrants and refugees. Raising the quality of basic education and expanding access to early-childhood education is key to increase potential growth and reduce inequality. Germany 1

1. Prices of natural gas sold to industry. 2. Electricity prices, when delivered to special contract customers. Source: Federal Statistical Office; ifo business surveys; and GfK. StatLink 2 https://stat.link/1eiyvk

OECD ECONOMIC OUTLOOK, VOLUME 2023 ISSUE 2: PRELIMINARY VERSION © OECD 2023

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Germany: Demand, output and prices 2020

Germany

2021

General government gross debt (% of GDP) General government debt, Maastricht definition³ (% of GDP) Current account balance (% of GDP)

2023

2024

2025

Percentage changes, volume (2015 prices)

Current prices EUR billion

GDP at market prices Private consumption Government consumption Gross fixed capital formation Final domestic demand Stockbuilding¹ Total domestic demand Exports of goods and services Imports of goods and services Net exports¹ Memorandum items GDP without working day adjustments GDP deflator Harmonised index of consumer prices Harmonised index of core inflation² Unemployment rate (% of labour force) Household saving ratio, net (% of disposable income) General government financial balance (% of GDP)

2022

3 396.7 1 706.6 749.6 730.4 3 186.6 14.5 3 201.2 1 473.3 1 277.7 195.6

3.1 1.5 3.1 -0.3 1.5 0.9 2.5 9.5 8.8 0.8

1.9 3.9 1.6 0.2 2.5 0.7 3.4 3.4 6.8 -1.2

-0.1 -0.7 -2.5 1.4 -0.6 0.0 -0.5 -0.7 -1.3 0.3

0.6 0.6 0.5 1.2 0.7 0.1 0.8 0.5 0.9 -0.2

1.2 1.4 0.6 1.7 1.3 0.0 1.3 2.3 2.4 0.0

3403.7 _ _ _ _ _ _ _ _ _

3.2 3.0 3.2 2.2 3.6 14.6 -3.7 79.3 69.2 7.8

1.8 5.3 8.7 3.9 3.1 11.5 -2.5 65.5 66.2 4.4

-0.2 6.3 6.2 5.2 3.0 11.7 -2.2 65.4 66.1 6.7

0.7 2.4 2.7 3.1 3.0 12.1 -1.6 66.3 66.9 6.9

1.8 1.7 2.1 2.3 2.9 11.9 -0.9 66.3 67.0 6.9

1. Contributions to changes in real GDP, actual amount in the first column. 2. Harmonised index of consumer prices excluding food, energy, alcohol and tobacco. 3. The Maastricht definition of general government debt includes only loans, debt securities, and currency and deposits, with debt at face value rather than market value. Source: OECD Economic Outlook 114 database.

StatLink 2 https://stat.link/tzn5v3

Weak export demand weighs on growth GDP stagnated in the first three quarters of 2023. Strong nominal wage gains and decreasing inflation stabilised real wages and private consumption. Due to falling energy prices, headline inflation dropped to 3% in October from 4.3% in September, while core inflation remained high at 4.3%. Business investment increased strongly since January despite rising interest rates and weak confidence, but exports declined. Industrial production has fallen since early 2023, with the strong decline in energy-intensive industries partly offset by support for other manufacturing sectors from easing supply chain bottlenecks and a large order backlog. Business expectations have weakened this year, but slightly improved since September, alongside factory sales data. Incoming manufacturing orders rose in August and September, mainly driven by export orders signalling a stabilisation of export demand. The unemployment rate remained at 3% in September.

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Germany 2

1. Harmonised index of consumer prices. 2. Harmonised index of consumer prices excluding excluding food, energy, alcohol and tobacco. Source: Federal Statistical Office; and Eurostat. StatLink 2 https://stat.link/phlwig

High interest rates weigh on global demand for investment goods, which make up a large share of German exports. Export values continued to decline in September and were 7.5% lower than September 2022. Monthly exports to other EU countries declined by 2.1% in September compared to August, while exports to non-EU countries increased by 1.7% in October, mainly driven by rising exports to the United States. Easing supply-chain bottlenecks will continue to help firms meet bulk orders in machinery and equipment industries and support manufacturing activity.

Public investment and fiscal incentives for private investment will support the recovery The national debt brake has been reinstated in 2023 after suspension during 2020-2022. Government consumption strongly decreased in 2023 due to the phase-out of pandemic-related health spending. However, the government plans to finance a range of policy priorities until 2026 using special extra-budgetary funds. These funds were endowed with about EUR 400 billion during the suspension of the debt brake, and their net spending is not bound by the national debt brake. The Climate and Transformation Fund (KTF) is supposed to spend about 1%, 1.5% and 1.2% of GDP in 2023, 2024 and 2025 respectively on subsidies and public investment to support the green transition. The net outflow from this fund, which will affect the fiscal deficit according to Maastricht criteria, will be smaller, as the fund also receives about 0.5% of GDP in carbon tax revenues in 2023, increasing to 0.8% in 2025 due to planned increases in the national carbon tax from EUR 30 to 50 per ton of CO2 during this period. A Supreme Court ruling in November 2023 resulted in a reduction of EUR 60 billion in borrowing allowances available for the KTF, which will particularly affect spending plans for 2025 and 2026. Defence spending will increase to 1.6% of GDP in 2023 and 1.9% of GDP in 2024 and 2025 due to spending from a special defence fund, which has been endowed with EUR 100 billion to improve defence equipment, while core budget spending for defence will likely remain around 1.3% of GDP.

 65 The electricity and gas price subsidies, which are in place until December 2023 with a possible extension until April 2024, are financed by the energy support fund, which has been endowed with EUR 200 billion. Falling retail energy prices will likely result in lower-than-expected fiscal costs from gas and electricity price subsidies, at about 0.9% of GDP in 2023 and 0.1% of GDP in 2024. Phasing out the value added tax reduction for gas as planned would help to strengthen energy saving incentives. The overall fiscal stance is expected to be contractionary in both 2024 and 2025, with cumulative tightening of around 1.7% of GDP, while public debt will slightly increase to 67% of GDP in 2025. The November ruling of the Supreme Court on the KTF might also have consequences on the use of other special funds, requiring additional financing of their spending plans through revenue increases and spending cuts in other areas, which might lead to further fiscal tightening.

The economy will slowly recover The economy is projected to contract slightly in 2023 and grow by 0.6% in 2024 and 1.2% in 2025. Private consumption will lead the recovery due to declining inflation and rising nominal wages amidst a tight labour market. High interest rates will continue to weigh on housing investment and export demand but easing supply chain bottlenecks and the order backlog will provide some support for manufacturing activity. Business investment will pick up due to high corporate savings and investment needs, supported by rising public investment and fiscal incentives for green investments. Government consumption will start to increase due to ageing-related spending for health and pensions, which is expected to increase by 0.3 percentage points of GDP until 2025, and rising public sector wages. Tighter monetary conditions, fading energy price pressures and fiscal tightening will help to bring down inflation from 6.2% in 2023 to 2.7% in 2024 and 2.1% in 2025. A major downside risk arises from geopolitical tensions leading to further energy or trade disruptions and the need to relocate supply chains. Continuing political uncertainty related to the financing of support policies for firms and workers during the green transition could weigh on investment and private consumption. If more fiscal tightening is needed to sustain the spending plans of extra-budgetary funds, GDP growth and inflation will be lower. A stronger recovery in China could significantly improve the outlook.

Advancing the green and digital transitions requires more investment To expand renewable energy supply and raise energy security, it is crucial to continue shortening the time needed to navigate complex planning and approval procedures at the municipal and Länder levels. Speeding up digitalisation will require more investment in digital infrastructure and a more rapid modernisation of the public sector, including by setting mandatory common IT standards and encouraging the harmonization of administrative procedures across levels of government. Increasing the efficiency of public spending by effective use of spending reviews, reducing regressive and environmentally harmful subsidies and tax exemptions, and improving tax enforcement could free up additional resources for needed public investment. To address rising labour shortages, which also risk derailing private and public renewable energy investment, the labour market participation of women, low-skilled and elderly workers needs to be raised by setting the right tax incentives, improving training and providing adult learning opportunities. Reforming the current joint income taxation of couples would help raise female labour supply and reduce gender disparities.