Germany as a growth engine – the current economic situation in Germany and Europe Annual reception of the Bundesbank's Regional Office in North Rhine-Westphalia
Check against delivery.
Ladies and gentlemen
It gives me great pleasure to be attending this event here at the Regional Office in Düsseldorf. In keeping with the forthcoming Rhineland carnival season, my speech will focus on the feel-good factor, that is the upbeat economic mood that is currently prevailing. This mood was borne out recently when Germany’s consumer climate index hit its highest level since 2001. And only a short while ago, in December, the European Commission’s monthly survey on economic sentiment saw the euro area reach its highest position since October 2000.
This might lead to you conclude that I’m about to deliver a speech full of uplifting data and forecasts. But that is not going to happen, and there are two reasons why not. First, you ought to be instinctively sceptical about the prospect of a Bundesbank Executive Board Member giving a chirpy speech. Second, whilst the upbeat reports that have been coming in are more than welcome after so many years of persistently negative headlines in Europe, I am sometimes inclined to think that the positive headlines fed to us by ticker news are fighting to outshine one another.
In view of this fact, carnival or no carnival, I shall bow to the expectations demanded of a Bundesbanker and give you a conventionally sober account of economic developments and the associated risk situation from the viewpoint of the Bundesbank.
So what is the current economic picture in Germany and Europe? And what does it imply for the near future?
These are the questions I shall focus on over the next fifteen minutes, if I may have your attention for that length of time.
2 Economic activity finally picks up: developments in Europe
I’d like to start by looking at the figures relating to the current sentiment prevailing in the European economy, especially in the euro area.
And I can begin with some good news. The gradual economic revival across the euro area led to a genuine upswing in 2017, with economic activity growing at a faster pace each quarter than it had just one year earlier in the same quarter. This culminated in a full-year growth rate of 2.4%. At 8.7% in December, the unemployment rate was well below its peak of 12.1% reached in 2013, putting it at its lowest level since January 2009. This indicates that the stable upward trend in the labour market has continued on the back of buoyant activity. Needless to say, this has not resolved the concerns about high youth unemployment and its social consequences in some member states, but developments have at least boosted confidence. And, according to a recent survey by Ernst & Young, 1.8 million new jobs are likely to be created in the course of 2018.
The important factor here is that the upswing is now broad-based across national borders and sectors alike. This development is also mirrored in the favourable economic climate. I have already mentioned the relevant European Commission index, which has climbed to a 17-year high.
Parallel to this, inflation is gradually rising. The December 2017 Eurosystem staff macroeconomic projections foresee consumer price inflation coming in at 1.4% for 2018, rising to 1.5% in 2019 and to 1.7% in 2020.
The very high level of confidence placed by enterprises and households in the healthy state of the economy by enterprises and households also suggests that the economic upturn will endure. The economic outlook for the euro area is looking good, thanks partly to the resilient domestic demand that has benefitted from the ongoing improvement in the labour market as well as favourable financing conditions, but also because of the sound path followed by the global economy. Accordingly, the International Monetary Fund has, for example, estimated that global economic growth will expand by 3½% in 2018. If this happens, then global economic growth potential will be almost fully achieved for the first time since 2008.
Experts from the IMF as well as the ECB have revised their current growth expectations for the euro area upwards. The December 2017 Eurosystem staff macroeconomic projections foresee annual real GDP increasing by 2.3% in 2018, 1.9% in 2019 and 1.7% in 2020. Compared with the September 2017 projections, the outlook for GDP growth has therefore been revised upwards substantially. Although growth will slow down over time, economic activity in the euro area will therefore probably exceed its potential over the next few years, too. Production capacity will already be fully utilised this year. And in some countries, labour shortages resulting from demographic changes will become apparent, hampering growth prospects.
3 Germany as a growth engine – the domestic economy
The upturn in the euro area is largely being driven by the healthy and sustained improvements in the German economy – in 2017, GDP growth outstripped the potential growth rate for the fourth consecutive year. Germany is the driving force behind the euro area’s economic growth.
Initial calculations by the Federal Statistical Office indicate that in 2017 real GDP rose by 2.5% in calendar-adjusted terms; in 2016 it climbed by +1.9%. The upturn is also broad-based within Germany. We can see evidence of this on both the demand and the supply side, where industrial activity is making a major contribution to growth. This development is accompanied by the lowest unemployment rate since German reunification, as well as record employment figures.
The Bundesbank expects a further increase of 2.5% this year. And in 2019 (+1.7%) and 2020 (+1.5%), Germany will likewise exceed its potential growth.
4 Thinking ahead and acting promptly
We ought not to succumb to euphoria over the positive economic data for the euro area – after all, many euro-area countries continue to face challenges. As indeed does Germany. I have already mentioned the repercussions of demographic developments for the labour market and growth potential. And as for the foreseeable fiscal consequences of an ageing population, now would be the right time to use the currently very favourable budgetary situation to equip ourselves to deal with them.
But another important point I would like to make is that euphoria can lead to arrogance. As you know, this is particularly true of financial markets. In this context, the name Minsky has frequently cropped up over the past few years; an economist who, as early as the 1980s, pointed out that people generally simply assume that positive developments will continue in the future, and, through their overoptimistic expectations and thus excessive risk appetite, cause bubbles to form. Financial markets therefore tend to be unstable. The risk of such unthinking optimism is particularly high during prolonged phases of growth. In an interview, former Bayern Munich goalkeeper Oliver Kahn once summed this up in far less academic terms by commenting that once your teammates start swapping investment tips in the changing room, it’s probably time to sell your shares.
So as you can see, it’s precisely during periods of positive economic development that risk is often underestimated. Therefore, given the current economic situation, it’s far better to be safe than sorry when it comes to reminding people not to lose sight of the risks. But objectively judging what degree of risk appetite is reasonable in the financial markets is often a complicated issue. Let’s take a look at the ongoing debate about price bubbles in Germany’s housing market, for example. A wide range of indicators can be observed here. Last year, for instance, the amount by which the housing market was overvalued in urban areas continued to increase. And most recently, credit standards for housing loans were eased slightly. Nonetheless, there has not been a significant overall decrease in lending standards here in Germany over the last few years. To sum up – we can see clouds on the horizon, but there’s no cause for alarm just yet.
The same applies to other risks, too. The early warning indicators that we observe do not currently point to a heightened risk situation. Some indicators, such as the number of business insolvencies, or risk premiums, are at historical lows. There is no alternative but to keep a constant watch on individual indicators.
But one thing is clear – even in times of an economic upswing, risks in the financial system won’t just disappear. At the global level there are geopolitical risks in the long term, for example, and while risks in connection with political uncertainty may be lower in the euro area, they have not been eliminated. Furthermore, the public finances of many euro-area countries remain susceptible to shocks and the large holdings of loans at risk of default in some countries in the euro area remain a challenge. European supervisors have gone to great lengths in this regard, and with palpable results. Some banks have been able to sharply reduce their holdings of non-performing loans. However, the task remains a very large one and needs to be tackled with considerable determination by the institutions concerned.
Additional risks and uncertainty have arisen as a result of the British referendum one-and-a-half years ago. Even if the probability of reaching a constructive agreement before the deadline of March 2019 has increased since December of last year, uncertainty remains. A lack of planability is highly detrimental, particularly to the financial sector on both sides of the English Channel. Therefore, we continue to strongly urge banks to get on track in good time and put forward a sound plan.
It’s not just the risks to the financial system that we need to keep an eye on; we clearly also need to monitor who bears the risks in the financial system, and whether they have the capacity to actually do so. Changes in this regard have been observed for a number of years now. For example, the capital ratio of enterprises outside the financial sector has been increasing continually over the last 20 years.
More recently, we have also seen a tendency for risks to be shifted from banks’ balance sheets to insurers. However, this does not apply to all risks. In the case of interest rate risk, in particular, a shift has been observed from private individuals to banks and savings banks. These institutions have markedly expanded their maturity transformation in the low-interest-rate environment, with the share of total lending attributable to loans with an interest rate lock-in period of more than ten years having increased considerably. By contrast, shorter interest rate lock-in periods and variable interest rates have become less prevalent. As a result, nearly one in two credit institutions in Germany is affected by heightened interest rate risk, which is calculated using the Basel interest rate shock scenario. This prescribed test scenario of a sudden, sharp rise in interest rates has the most severe consequences for the vast majority of institutions.
Banking supervisors have responded. Given the major significance of interest rate risk in the banking business, it is only right that the supervisory process has recently been adjusted and, as a rule, leads to explicit capital add-ons for interest rate risk. The supervisory process thus affects all credit institutions. Employees in the Bundesbank’s Regional Offices in the area of banking supervision will know what I am talking about. Interest rate risk is subject to close scrutiny in the supervisory review and evaluation process (or SREP, for short). At regular intervals, institutions must be able to prove to supervisors that they can actually bear the risks they have entered into as well as adequately oversee and manage them. The measures at supervisors’ disposal include capital surcharges and qualitative instructions.
As a final point, I would like to briefly touch on the general internal capital adequacy of credit institutions. After all, when it comes to general risks to the financial system, the capital levels of banks and savings banks are one of the key safeguards. Since the crisis, institutions have significantly improved their capital buffers. The capital ratio of German institutions was nearly 17% on average at the end of September last year. This was achieved partially by building up capital, but also by scaling back risk-weighted assets. Ultimately, it’s not so important how these higher capital buffers were achieved. The crucial thing is that they make an important contribution to financial stability, not least in light of the numerous risks that we must continue to take heed of, even in a favourable economic environment.
Ladies and gentlemen, the broad-based recovery in the euro area – buttressed not least by the continuing economic upswing in Germany – is a welcome development. However, I would like to stress that statements on the economic situation and the risk landscape are ultimately nothing more than snapshots at a given moment in time.
And while I opened my speech with the topic of carnival, allow me, if you will, to end on a serious note. As Schopenhauer once said, "
change alone is eternal, perpetual, immortal." Positive trends can weaken or reverse, and sometimes it is during a positive development that the seeds of overconfidence and excessive euphoria are sown.
Thank you for your attention.
- Harmonised Index of Consumer Prices (HICP).
- The IMF’s GDP projections: 2017: 2.1% (+0.2 percentage point); 2018: 1.9% (+0.2 percentage point).