Research Dept. News
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Monthly Report, num 291 - May 2006
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European Union - Germany
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Germany: tax package in sight
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Recovery anticipated by confidence indicators in Germany beginning to be confirmed by real figures.
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Following several months during which qualitative indicators showing clear increases have been running side-by-side with a lack of positive real figures, that is to say, showing a gap between what the Anglo-Saxons call soft and hard data, the breach has begun to narrow. While indicators, such as the industrial activity index of the IFO Institute, are standing at highs for recent years (in April this index marked up its highest level since 1991), the recent trend in retail sales and industrial production, for example, is the best in recent times. With regard to the former, these went from growth of 0.2% year-to-year in the fourth quarter to jump up to 1.5% on average in January and February. Industrial production in January, in turn, added a fifth consecutive month at growth levels of more than 3% year-to-year.
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The improved economic situation also showed up in two key sectors, namely construction and services. In the first case, the sharp rise in building permits for new houses in December and January suggests more drive in a sector that has been very much hurt in recent years. Services are running a similar course with a confidence indicator that moved up to the level of 17 points on average in the first quarter, six points more than in the previous quarter.
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Industry, services and construction recording higher growth rates but burden remains of labour market still doing poorly.
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The trend in the labour market is less satisfactory. While the unemployment rate has been dropping moderately in recent months, neither the level reached (11.4% of the labour force in March, an historically high figure) nor the increase recorded that month end up being positive.With regard to inflation, Germany has not departed from the dominant pattern in the European Union and recorded a further drop in inflation in March (down to 1.8% year-to-year), three decimals below the figure for the month before.
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Although, as noted, the short-term picture is positive overall, the prospects for 2007 are more uncertain. Particularly troubling are the possible negative effects of the tax adjustment package the Merkel government approved at the end of February. Aimed at reducing the government deficit, this package combines an increase in the ordinary rate of the value added tax (VAT) from 16% to 19% with a reduction in taxation on wages for work through a reduction of two points in unemployment contributions.
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While impact of fiscal adjustment will be specific and limited, uncertainty lingers about Germany’s prospects for 2007.
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According to official estimates, these measures, along with others of less importance, will make it possible to reduce the government deficit by the equivalent of 0.4% of the GDP in 2007. Nevertheless, two additional effects arising from these tax adjustments will be earlier buying decisions by households and an increase in consumer prices. The question is, will these two factors have a decisively adverse effect on Germany’s economic results in coming years?
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If we can go by all available estimates, the answer is “No”. According to simulations by Euroframe, a trans-European consortium of economic research institutes, the fiscal package will cause scarcely 1% of consumption in one quarter to be moved forward from 2007 to 2006, that is to say, it will have a very moderate impact. The effect on prices will be more noticeable. According to Euroframe, inflation will move up by close to one percentage point in 2007 although this increase in prices may not be repeated in 2008 or 2009. In overall terms, the fiscal adjustment will scarcely subtract 0.1% to Germany’s growth in each of the next three years.
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