## Germany: Staff Report for the 2018 Article IV Consultation (cr18208) ## Source details **Canonical URL:** [Germany: Staff Report for the 2018 Article IV Consultation (cr18208)](https://www.imf.org/-/media/files/publications/cr/2018/cr18208.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18208.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18208.pdf.json) --- ### Overview and recent performance - Real GDP growth: 2.5 percent in 2017; slowed to 0.3 percent (qoq) in Q1 2018. - Drivers: export rebound and pickup in investment in 2017; Q1 2018 slowdown reflected correction and temporary factors (strikes, flu, early Easter). - Capacity utilization: already-high and continued to rise. - Labor market: unemployment (ILO) reached 3.6 percent in 2017 (new post-reunification low). - Inflation: headline and core about 1.5 percent by end-2017 and picked up in early 2018. ### Labor market, wages, and inflation - Unemployment rate (ILO): 4.2 (2016), 3.7 (2017), 3.6 (2018), 3.5 (2019). - Employment growth: 2.4 percent (2016), 1.1 percent (2017), 0.6 percent (2018), 0.4 percent (2019). - Nominal wage growth: increased moderately in 2017 and early 2018; staff finds nominal wage growth broadly consistent with subdued productivity growth and inflation expectations. - Inflation (CPI/harmonized): 0.4 percent (2016), 1.7 percent (2017), 1.8 percent (2018), 1.7 percent (2019). - Staff finding on immigration: immigration not found to have had a significant dampening impact on wage growth over analyzed period; composition and competition effects roughly offset (see Annex IV and 0.56 percent section). ### Fiscal position and public finances - General government surplus: 1.0 percent of GDP (2016) → 1.2 percent of GDP (2017). - Structural balance: broadly flat at 1 percent of GDP in 2017. - Public debt ratio: 68.2 (2016) → 64.1 (end-2017) → projected 60.0 (2018) → 56.1 (2019). - Fiscal table key figures (% of GDP): - Fiscal balance: 1.0 (2016), 1.2 (2017), 1.4 (2018), 1.4 (2019). - Revenue: 45.0 (2016), 45.1 (2017), 45.3 (2018), 45.2 (2019). - Expenditure: 44.0 (2016), 44.0 (2017), 43.9 (2018), 43.8 (2019). ### Financial system, credit, and housing - Credit and monetary indicators: - Credit to private sector (% change): 3.5 (2016), 4.2 (2017). - Broad money (M3) % change (end of year): 5.7 (2016), 4.3 (2017). - 10-year government bond yield (%): 0.2 (2016), 0.4 (2017). - Private credit-to-GDP ratio: around 100 percent of GDP (overall). - Mortgage and housing: - House prices accelerated in dynamic urban areas; mortgage lending accelerated in such areas. - Household debt: 53 percent of GDP at end-2017. - Debt-service-to-income ratio: low and declining. - Banking and insurance sector: - Regulatory capital: adequate; profitability weak. - Life insurers: extensive reliance on guaranteed products; restructuring underway; majority (~70 percent) rely on transitional measures for Solvency II calculations. - Supervisory recommendations: continued attention to restructuring plans and reducing interest rate risk. ### External sector and saving-investment dynamics - Current account (percent of GDP): 8.5 (2016), 8.0 (2017), 8.3 (2018), 8.1 (2019). - Trade balance (% of GDP): 7.9 (2016), 7.6 (2017), 7.6 (2018), 7.3 (2019). - Exports of goods (% of GDP): 37.9 (2016), 38.9 (2017), 39.4 (2018), 40.0 (2019). - Imports of goods (% of GDP): 29.4 (2016), 30.8 (2017), 31.3 (2018), 32.0 (2019). - NIIP: 60 percent of GDP at end-2017. - Reserves minus gold (US$ billions): 59.6 (2016), 59.4 (2017). - External debt (% of GDP): 148.0 (2016), 140.5 (2017). - Drivers of external surplus: rising corporate net saving (NFC net lending increased about 5 percentage points of GDP from 2001 to 2015), high household saving, increased government saving since 2001; declining dividend payouts and precautionary motives post-GFC. ### Outlook and risks - Near-term: expansion expected to continue. - Medium/long-term: growth expected to slow markedly due to unfavorable demographics and productivity trends. - Key risks: - Significant rise in global protectionism. - A hard Brexit. - Reassessment of sovereign risk in the euro area leading to renewed financial stress. - Domestic risk: insufficient progress in banking sector restructuring could rekindle financial stress. ### Box: Evolution of the BoP Financial Account (highlights) - Financial account trended up since 2001, mirroring CA surplus; net portfolio investment (PI) largest component since the GFC. - Post-GFC: outward PI recovered; inward PI remained low and turned negative as foreign investors sold German sovereign bonds to the Bundesbank under ECB APP, making net PI large and positive. - Other investment (OI) flows and TARGET2 dynamics: TARGET2 balance changes correspond to OI gross flows; ECB APP and safe-haven shifts altered cross-border deposit/settlement flows. - Direct investment (DI): DI abroad ~3 percent of GDP; inward DI ~2 percent of GDP historically. ### Major policy recommendations and priorities (Executive Directors and staff) - Fiscal policy and public investment: - Use fiscal space within fiscal rules to enhance growth potential by increasing public investment in physical and human capital. - Address municipal capacity constraints and prepare a comprehensive investment plan; operationalize the Federal Transport Agency without delay. - Labor supply and pensions: - Reinvigorate measures to lengthen working lives and increase labor force participation of older workers. - Prioritize incentives for labor supply: expand childcare and after-school programs, reduce the labor tax wedge, provide additional funding for primary education and life-long learning. - Structural reforms to boost productivity and investment: - Reinvigorate competition-enhancing reforms in network industries and professional services. - Support entrepreneurship and venture capital (including access to venture capital and tax incentives for R&D to SMEs); expand e-government services. - Complete digital transformation and implement high-speed internet/5G plans without delay. - Housing market and macroprudential: - Address housing market vulnerabilities by strengthening the macroprudential toolkit (legal LTV caps and amortization exist; income-based instruments DTI/DSTI recommended) and urgently address city-level data gaps. - Consider lowering effective tax burden on new construction and re-examining zoning restrictions in high-demand areas. - Financial sector: - Accelerate restructuring in banking and life insurance sectors; reduce interest rate risk; pursue consolidation and cost cuts where feasible. - Maintain supervisory attention to restructuring plans and interest rate sensitivity; use Pillar II measures where appropriate. - Balance fiscal use for growth with maintaining buffers for demographic and economic risks. ### New government’s budget package and projected effects (Box 2) - Package size: €46 billion (about 1½ percent of 2017 GDP) in additional spending and tax cuts over 4 years. - Main measures: high-speed internet expansion (financed by 5G license auctions), all-day childcare and after-school programs, housing support, training for refugees, education, vocational training, R&D support. - Phasing out of solidarity tax surcharges starts in 2021; equalizing health insurance contributions and reducing unemployment insurance contribution by 0.3 percentage point noted. - Estimated macro effects (accumulative): - Fiscal package ~1½ percent of 2017 GDP (cumulative fiscal impulse of 1 percent of GDP) → boost GDP by about ½ percent over 4 years. - Increase public debt-to-GDP ratio by about 1¼ percent of GDP. - Decrease the current account by about ¼ percentage point of GDP. - Bulk of effects in 2019–21 due to implementation lags. - Cumulative effect table excerpt (2018–2021, percent of GDP by year): - Revenue: 0.0 0.0 0.0 -0.3 - Expenditure: 0.0 0.3 0.3 0.4 - Effect on GDP (%): 0.4 (cumulative) - Effect on CA (%): -0.3 (cumulative) - Effect on Debt (% of GDP): 1.3 (cumulative) ### Investment, education, and human capital (Annex VIII highlights) - General government investment: around 2–2¼ percent of GDP (recent years); declined from ~3 percent in early 1990s. - Municipalities: large role in investment decline; perceived municipal investment backlog €126 bn (3.9 percent of GDP) in 2017 (KfW), with traffic infrastructure 27 percent and education 26 percent of backlog. - Net capital stock: stagnant since 2000; municipal net capital stock declined since early 2000s. - Education spending (public + ALMP): around 4¾ percent of GDP in recent years vs 6–6½ percent in other advanced EU countries. - Compulsory instruction time for primary education: 2,822 hours in Germany vs 4,626 hours OECD average and 4,339 hours EU22 average. - Recommendations: use fiscal space to raise public investment, prioritize municipal capacity, expand full-day primary education by 2025, and strengthen lifelong learning. ### Housing valuation and city-level findings (city panel model) - City-level overvaluation estimates (2017): - Munich: 46 percent above fundamentals. - Hannover, Frankfurt, Hamburg: gaps between 25 and 30 percent. - Stuttgart, Dusseldorf: 10–15 percent overvaluation. - Population-weighted average of 7 biggest cities: house prices 21 percent above fundamental level. - Model drivers: real GDP per capita, mortgage rates, population density, employment growth, construction prices, lagged real estate investment. - Robustness: results broadly robust; range for Munich 45–50 percent overvaluation using alternative mortgage-rate concepts. ### External position assessment and REER - CA assessment (2017): - Actual CA: 8.0 (percent of GDP). - Cyclically-adjusted CA: 8.3. - EBA CA Norm: 2.8. - EBA CA Gap: 5.5. - Staff Adj.: 0.5. - Staff CA Gap: 5.0. - Staff REER assessment (2017): REER undervaluation of 10–20 percent; refined EBA REER Level model yields 14 percent undervaluation; CA-gap implied undervaluation 15–30 percent. - Staff view: external position substantially stronger than implied by medium-term fundamentals and desirable policies; policy action needed for external rebalancing. ### Annex findings on NFC savings and corporate behavior (Annex VII) - NFC gross saving rates rose over last two decades; NFC net lending increased substantially into CA surplus. - Drivers post-2007: falling dividend payout rates (from ~50–55 percent to <45 percent) and precautionary motives; reinvested FDI roughly constant since 2001. - Leverage: debt-to-equity declined to about 50 percent (historical low); firm-level deleveraging notable. - Firm-level Orbis evidence (2004–2015): saving rate increase ~1.6 percentage points in sample; small and medium firms contributed strongly to rising gross NFC saving. ### Annex on immigration and wages (Annex VI and 0.56 percent section) - Composition effect of immigration (2012–2016): aggregate pure accounting effect -0.56 percent (or -0.14 percent per year) on wages. - Breakdown (percent): nationality -0.18; sex 0.02; age -0.05; qualification -0.02; sector -0.27; job/working time -0.08; region 0.02; total -0.56. - Competition effect: estimated marginal effect if migrant share rose by 1 percentage point → wages increase by 0.5 percent; observed yearly average migrant-share increase 0.44 percentage points → competition effect ~0.22 percent per year. - Net effect: composition negative and competition positive → immigration had a negligible (slightly positive) net effect on aggregate wages over 2012–2016. - Micro WLS panel estimates (selected coefficients, dependent = log wage; N=59,840): - migrant_intensity_t-1: 0.005 (S.E. 0.000) - German: 0.005 (S.E. 0.000) - EU: -0.056 (S.E. 0.003) - 8 asylum countries: -0.148 (S.E. 0.012) - male: 0.053 (S.E. 0.001) - qualification (high): 0.282 (S.E. 0.001) - year fixed effects: 2016: 7.650 (S.E. 0.003) - Model statistics: F(40, 59800) = 4604598.89; Prob > F = 0.0000; Root MSE = 0.0111. ### IMF staff appraisal (summary) - Short-term: robust growth supported by consumption, investment, exports. - Medium-term: growth will revert toward potential limited by demographics and low productivity growth. - Inflation: headline and core low but expected to pick up with tight markets. - Policy priority: use current cyclical upswing—“golden opportunity”—to adopt growth-enhancing fiscal measures and structural reforms to raise productivity, labor supply, and private investment, and to facilitate external rebalancing. *Germany: Staff Report for the 2018 Article IV Consultation, International Monetary Fund, June 15, 2018.* ### 2.5 percent. Already-high capacity utilization continued to rise and the labor market tightened ### 2.5 percent. Already-high capacity utilization continued to rise and the labor market tightened ### Overview and recent performance - Real GDP growth picked up sharply in 2017, reaching 2.5 percent, driven by an export rebound and a pickup in investment. - In Q1 2018, growth slowed to 0.3 percent (qoq), reflecting a normal correction after unusually strong late-2017 growth and temporary factors (strikes, a particularly nasty flu outbreak, and early Easter holidays). - The labor market tightened further; employment growth moderated but job creation brought the unemployment rate (ILO) to 3.6 percent in 2017, a new post-reunification low. - Headline and core inflation reached about 1.5 percent by end-2017 and picked up further in the first several months of 2018. ### Labor market, wages, and inflation - Labor market developments: - Unemployment rate (ILO): 4.2 (2016), 3.7 (2017), 3.6 (2018), 3.5 (2019). - Employment growth: 2.4 percent (2016), 1.1 percent (2017), 0.6 percent (2018), 0.4 percent (2019). - Wage and price dynamics: - Nominal wage growth increased moderately in 2017 and early 2018. - Inflation: 0.4 percent (2016), 1.7 percent (2017), 1.8 percent (2018), 1.7 percent (2019). - Staff analysis: nominal wage growth broadly consistent with subdued productivity growth and inflation expectations; immigration not found to have had a significant impact over the analyzed period. ### Fiscal position and public finances - General government surplus rose to 1.2 percent of GDP in 2017 (from 1.0 percent in 2016), the highest level since reunification. - Fiscal stance in 2017 was broadly neutral; the overall structural balance was flat at 1 percent of GDP. - Public debt ratio decreased to 64.1 percent of GDP at end-2017 (from 68.2 percent in 2016). - Fiscal table key figures: - Fiscal balance (% of GDP): 1.0 (2016), 1.2 (2017), 1.4 (2018), 1.4 (2019). - Revenue (% of GDP): 45.0 (2016), 45.1 (2017), 45.3 (2018), 45.2 (2019). - Expenditure (% of GDP): 44.0 (2016), 44.0 (2017), 43.9 (2018), 43.8 (2019). - Public debt (% of GDP): 68.2 (2016), 64.1 (2017), 60.0 (2018), 56.1 (2019). ### Financial system, credit, and housing - Credit and monetary indicators: - Credit to private sector (% change): 3.5 (2016), 4.2 (2017). - Broad money (M3) (end of year, % change): 5.7 (2016), 4.3 (2017). - 10-year government bond yield (%): 0.2 (2016), 0.4 (2017). - Credit trends: - Total credit accelerated in 2017 as households and firms took advantage of low interest rates, but remained broadly in line with nominal GDP growth. - Overall private credit-to-GDP ratio remained around 100 percent of GDP. - Credit to non-financial corporates picked up in 2017; mortgage lending accelerated in dynamic urban areas. - Housing market: - House prices accelerated further in dynamic urban areas, driven by continued urbanization, an inelastic housing supply, and easy financing conditions. - Accelerating house prices in Germany’s most dynamic cities deserve close monitoring, but lack of granular city-level data prevents a full assessment. - Banking and insurance: - Regulatory capital remained adequate, but profitability in the banking sector remained weak, reflecting structural factors, crisis legacies, and the low interest rate environment. - Some banks remain under close supervisory scrutiny. - Life insurance sector profitability remains an issue due to extensive reliance on guaranteed products; low rates have forced some restructuring. - Continued supervisory attention to restructuring plans and reducing interest rate risk in banking and insurance recommended. ### External sector and saving-investment dynamics - Current account and trade: - Current account balance (% of GDP): 8.5 (2016), 8.0 (2017), 8.3 (2018), 8.1 (2019). - Trade balance (% of GDP): 7.9 (2016), 7.6 (2017), 7.6 (2018), 7.3 (2019). - Exports of goods (% of GDP): 37.9 (2016), 38.9 (2017), 39.4 (2018), 40.0 (2019). - Imports of goods (% of GDP): 29.4 (2016), 30.8 (2017), 31.3 (2018), 32.0 (2019). - Net International Investment Position (NIIP) climbed to 60 percent of GDP at end-2017. - Drivers of external surplus: - Rising corporate net saving (NFC net lending increased about 5 percentage points of GDP from 2001 to 2015). - Household saving remained high and stable; government saving increased by 4 percentage points of GDP since 2001. - Since the GFC, declining dividend payout rates and precautionary motives contributed to rising NFC saving. - Reserves minus gold (billions of US$): 59.6 (2016), 59.4 (2017). - External debt (% of GDP): 148.0 (2016), 140.5 (2017). ### Outlook and risks - Near-term outlook: expansion expected to continue in the near term. - Medium- to long-term outlook: growth expected to slow markedly over the medium to long term due to unfavorable demographics and productivity trends. - Short-term/substantial risks: - Significant rise in global protectionism. - A hard Brexit. - A reassessment of sovereign risk in the euro area leading to renewed financial stress. - Any of the above could adversely affect exports and investment. ### Key policy recommendations and priorities (as summarized by Executive Directors and staff) - Use fiscal space within fiscal rules to enhance growth potential by further increasing public investment in physical and human capital and fostering labor supply. - Reinvigorate competition-enhancing reforms in network industries and professional services and improve the environment for entrepreneurship and venture capital (including access to venture capital and tax incentives for R&D to small- and medium-size enterprises). - Consider pension and labor market reforms to lengthen working lives and increase labor force participation of older workers. - Prioritize measures that incentivize labor supply, expand childcare and after-school programs, reduce the labor tax wedge, and provide additional funding for primary education and life-long learning. - Address housing market vulnerabilities by strengthening the macroprudential toolkit and urgently addressing data gaps at the city level. - Accelerate restructuring in the bank and life insurance sectors to durably strengthen resilience; maintain supervisory attention to restructuring plans and interest rate risk. - Balance using fiscal space for growth-enhancing spending with maintaining strong buffers for potential economic risks and upcoming demographic challenges. *Germany: Staff Report for the 2018 Article IV Consultation, International Monetary Fund, June 15, 2018.* ### Box 1. The Evolution of the Balance of Payment’s (BoP) Financial Account ### Box 1. The Evolution of the Balance of Payment’s (BoP) Financial Account ### Trends in the financial account and portfolio investment (PI) - Germany’s financial account balance has trended up since 2001, mirroring the current account surplus. - Net portfolio investment (PI) has been the largest component since the GFC; prior to that “other investment” (OI) flows were more important. - Before the GFC: - The net PI balance was relatively small, but gross in- and outflows were large. - German investors increased holdings of euro area sovereign bonds; foreigners invested in German long-term government debt and private sector securities. - Gross PI flows peaked in 2007. - After the GFC: - Outward PI recovered to pre-crisis levels following a pause in 2008–09. - Inward PI remained low and turned negative in recent years as foreign investors sold German sovereign bonds to the Bundesbank in the context of the ECB’s Asset Purchase Program (APP). - The result: net PI has turned large and positive, reflecting reduced foreign investment in German sovereign bonds. ### Other investment (OI) and TARGET2 dynamics - Quantitative easing by the ECB altered OI patterns. - Up to 2009, OI outflows largely reflected German banks’ lending and accumulation of deposits abroad. - In 2009 this pattern sharply reversed and has not noticeably resumed as German banks reduced cross-border exposures. - After the GFC, OI outflows were strongly driven by changes in the TARGET2 balance of the Bundesbank, which is recorded as a capital outflow in the BoP. - 2010–12: shifts in market sentiment during the European debt crisis led to “safe-haven” investment in Germany; liquidity provided by central banks elsewhere partly ended up deposited in Germany, creating Bundesbank claims on the ECB. - After 2014: the growing TARGET2 balance related to the ECB’s APP—foreign investors sold non-German bond holdings to a non-German central bank in the euro area, deposited proceeds in a German bank, and Bundesbank TARGET2 claims rose. - While TARGET2 balance changes have a gross (OI) flow correspondence in the financial account, the net impact is lower because a liability of domestic banks towards foreign depositors is also created. - Footnote in the box: The balance of the capital account is close to zero as a share of GDP. ### Direct investment (DI) - Direct investment abroad and foreign DI in Germany have fluctuated around 3 and 2 percent of GDP, respectively (with some interim post-GFC decline in inward DI). - German corporates have traditionally: - Acquired equity (including through retained earnings) in Europe and in the US. - Lent to controlled companies in lesser amounts. - Inward investment originates mostly in the Euro Area and reflects in part lending to parent (German) companies (reverse investment). ### Implications and observed links - The changing composition of gross flows (large gross PI and OI shifts) underlies the rise in net financial account balances despite reduced foreign purchases of German sovereign debt. - ECB unconventional monetary policies (APP) influenced both PI and OI patterns via bond purchases and cross-border deposit/settlement flows recorded in TARGET2. - German banks’ reduced cross-border exposures after the GFC diminished the prior OI outflow channel tied to bank lending and deposits abroad. *Sources: Deutsche Bundesbank, Haver Analytics and IMF staff calculations.* ### 19. More forceful policy action will be needed to decisively address Germany’s medium- ### 19. More forceful policy action will be needed to decisively address Germany’s medium- ### Overview and policy priorities - The current cyclical upswing presents a "golden opportunity" for bolder action to address medium-term challenges and facilitate external rebalancing. - Policies should boost potential growth by increasing productivity growth, labor supply and investment to offset aging effects on long-term living standards. - A multi-pronged approach is needed: use the entire fiscal space to support growth-enhancing policies alongside structural reforms to boost productivity growth and incentives for private investment. - Concerted policy action that increases productivity growth and labor supply can improve expectations of future growth, provide greater incentives for domestic investment in Germany, facilitate external rebalancing, and have positive outward spillovers for trading partners. - Key priorities: - Investing more in physical and human capital. - Boosting labor supply. - Supporting entrepreneurship. - Structural reforms to increase productivity growth and improve incentives for domestic private investment. - Many priority areas are under the purview of state and municipal governments, where the fiscal space primarily exists. *Authorities’ Views (summary)* - Authorities view the CA surplus as the result of private sector decisions and demographic factors, not domestic policy distortions, but concur with staff on desirability of promoting higher domestic investment. - They expect the CA surplus to remain large over the next few years but to decline as baby boomers retire. - Authorities noted measures already implemented in the previous legislature and more foreseen in the new coalition agreement to raise domestic investment. - The Bundesbank assesses the REER to be close to equilibrium based on price competitiveness and relative productivity indicators. ### The New Government’s Budget Proposal (Box 2) - The new government’s package: €46 billion (about 1½ percent of 2017 GDP) in additional spending and tax cuts, spread over the next four years. - Main spending measures: expansion of the high-speed internet network (financed by auctioning 5G licenses); investment in all-day childcare and after-school programs; additional housing support and training for refugees; support for education, vocational training, and R&D activities. - Phasing out of the solidarity tax surcharges for low- and middle-income households starts in 2021 to help trim the labor tax wedge. - Increases in targeted benefits (supplementary allowance to combat child poverty, additional support for the long-term unemployed) to reduce poverty risks. - Tax revenue overperformance allocated to addressing “bracket creep” and further supporting digitalization. - Estimated macro effects (relying on usual multipliers for public investment, consumption tax and transfers): - The fiscal package of about 1½ percent of 2017 GDP (an accumulative fiscal impulse of 1 percent of GDP) would boost GDP by about ½ percent over 4 years. - Increase the public debt-to-GDP ratio by about 1¼ percent of GDP. - Decrease the current account by about ¼ percentage point of GDP. - Normal implementation lags imply bulk of effect in 2019–21. - Table excerpt (Cumulative Effect of the Government Program (2018 - 2021)): - Revenue: 0.0 0.0 0.0 -0.3 (in percent of GDP by year) - Expenditure: 0.0 0.3 0.3 0.4 - Effect on GDP (%): 0.4 (cumulative) - Effect on CA (%): -0.3 (cumulative) - Effect on Debt (% of GDP): 1.3 (cumulative) ### B. Investing in Physical and Human Capital - Germany has ample fiscal space that should be used to further increase investment in physical and human capital. - Recent increases in public investment are welcome, but further efforts are needed—public investment has declined since the 1990s, driven by municipalities, leading to a stagnant public capital stock. - Germany’s government investment appears to be below that of other advanced economies even after accounting for investment grants and public-private partnerships (Annex VIII). - Municipal investment has recently picked up, supported by the Municipal Investment Promotion Program and Partnerschaft Deutschland (PD). - Constraints and recommendations at municipal level: - Regional disparities in funding and planning capacities and lengthy administrative procedures hinder infrastructure projects. - Staffing constraints hinder investment planning; PD is reaching capacity constraints. - Consider prioritizing PD services to municipalities where public investment has been delayed most or provide additional financial support for hiring external consultants competitively. - Prepare a comprehensive investment plan covering all levels of government. - Operationalize the Federal Transport Agency without delay to accelerate transport investment. - Human capital: - Germany’s education is high quality but trails best-performing countries; compulsory instruction time for primary education is 2,822 hours in Germany, compared to 4,626 hours for the OECD average and 4,339 hours for the EU22 average. - Scope exists for expanding education spending; the government plans to provide full-day primary education to all students by 2025 through enhanced federal–Länder collaboration. - Expanding full-day primary education, high-quality early childcare and early childhood education would strengthen basic skills, enhance integration of students with migrant backgrounds, support poverty reduction, and promote labor participation of women. - Large share of German jobs, concentrated in middle-skill routine tasks, are vulnerable to automation; the probability that the median job is automated is high in Germany. - Digital skills of German adults and participation rates in life-long learning trail peers; participation rate of population aged 25–64 in education and training during the last four weeks is used as a measure. - Providing lifelong learning opportunities in collaboration with employers is crucial to prepare for changing skills demands. - Authorities’ Views: - Ministry of Finance officials argued no space at federal level due to the “black zero” (no new debt at Federal level) and Germany’s national fiscal rule; spending increases should be financed through reductions of other expenditures. - Authorities agreed further increases in public investment are needed and bottlenecks at municipal level must be addressed; tackling this is a new government priority. - Government reaffirmed that public funds should not crowd out private investment in digital infrastructure. - Education policy is the remit of the Länder, but authorities see scope for enhancing quality and budget allocation; 2017 constitutional changes enabling federal funding to weak municipalities could help. ### C. Increasing Labor Supply - Fiscal space and structural reforms should aim to boost labor supply of women, older workers, and migrants. - In 2017, 65 percent of women with children below the age of 7 worked part-time. - Measures to boost labor supply: - Further expand childcare and after-school programs to increase opportunities for women to pursue full-time employment. - Reduce the labor tax wedge on low-income households and secondary earners to improve incentives for labor force participation. - Income taxed at household level and cost-free healthcare coverage for non-working spouses produce a high effective marginal tax rate for second earners. - New government plans: equalize health insurance contributions between employees and employers and reduce the unemployment insurance contribution by 0.3 percentage point—steps to reduce the labor tax wedge. - Refugee integration: - Backlog of pending asylum applications reduced substantially; most refugees participating in language and culture classes; some have entered the labor market. - New government committed to continue funding refugee programs and enhancing opportunities for labor market entry and poverty risk reduction. - Pensions and prolonging working lives: - Public pension expenditure is expected to rise by 1.9 percentage point of GDP between 2016 and 2040 (compared with an average of 0.8 percentage point of GDP increase in the EU). - Pension replacement rates are projected to decrease, increasing the risks of old-age poverty. - Coalition agreement measures: cap the pension contribution rate at 20 percent and set a floor on replacement rates (under the national definition) at 48 percent until 2025. - This measure expected to not have a large fiscal cost up to 2025 but would be burdensome if it stayed in place afterwards. - Reforms encouraging higher participation rates among older workers and longer working lives would be more durable and growth-friendly, reduce the need to save for retirement, and help reduce the large current account surplus. - Authorities’ Views: - Authorities agreed tax reforms should incentivize labor force participation; reductions in the solidarity surcharge and unemployment contributions reduce the tax wedge. - Further measures, such as reducing bracket creep, are being contemplated. - Authorities committed to rapid integration of refugees into the labor market and to assessing policy effectiveness. - Government noted political challenges to further increase statutory retirement age (considered already high at 67) without simultaneous labor market reforms to foster hiring of older workers; exploring incentives for life-long learning. ### D. Boosting Productivity Growth and Private Investment - Structural reforms should enhance the environment for private investment and increase productivity growth—priority areas: supporting entrepreneurship and venture capital, completing the digital transformation, advancing energy transition, and embracing competition-enhancing structural reforms. - Entrepreneurship and venture capital: - Expanding venture capital would support entrepreneurial activity and investment in intangible assets (including R&D), where banks are less active, potentially reducing the need for firms to save and facilitating external rebalancing. - New business creation has been on a declining trend for a decade, suggesting limited entrepreneurial activity essential for technological diffusion and productivity growth. - Government provides substantial support for early-stage financing, but relatively small size of venture capital funds limits support for start-ups at the growth stage. - Recommendation: further explore ways to encourage provision of scale-up capital, including in the context of the EU-wide capital markets union. - Government initiatives to simplify tax administration and plans to introduce tax incentives for R&D for small- and medium-size enterprises should support entrepreneurship. - Expand e-government services (Germany trails peers) to reduce administrative burdens for entrepreneurs. - Digital infrastructure: - DIGITAL Economy 2017 indicates digitalization picking up especially in small and medium enterprise sector. - High-speed nation-wide internet connections and higher ICT capital per worker—where Germany lags peers—are necessary to remain an innovation leader. - New government plans to increase investment in digital infrastructure are welcome and should be implemented without delay. - Completing digital transformation requires additional private sector investment; government should ensure incentives and regulations are supportive and funding available where needed. *International Monetary Fund staff report extract.* ### 32. Germany’s energy transformation is underway, and a clear strategy for reducing ### Germany’s energy transformation is underway, and a clear strategy for reducing ### Energy transformation and greenhouse gas strategy - Germany is on track to meet its renewable energy (RE) target. - The government has set ambitious goals to cut greenhouse gas emissions—some of which will be missed. - A clear and credible strategy for meeting greenhouse gas emissions targets should be articulated to reduce uncertainty about future energy costs and transition. - Elements of strategy could include: - measures to promote public transportation, - support the use of electric vehicles, - phase out coal-fired power production. - The creation of a commission to establish a process for phasing out coal is welcome. - The 2017 RE Sources Act substituted the old “feed-in” tariff system with a competitive auction system for wind, solar and biomass production, helping contain the cost of electricity for consumers and allowing the government to retake control of the RE supply. ### Competition in network industries and professional services - Efficiency-boosting reforms in network industries and professional services could have an important and positive impact on productivity, investment, and long-term growth. - Limited progress since the last consultation in enhancing competition in the railways or postal services; incumbents’ dominant positions largely unchanged. - The regulator should make use of its powers to avoid discrimination against new entrants; corrective regulatory measures should be taken were the status quo to persist. - Professional services viewed by staff as overregulated: exclusive rights, compulsory chamber membership, and regulation on prices and fees stifle competition. - A National Action Plan to reform the regulatory environment for lawyers, patent attorneys, tax advisors and auditors was submitted to the EC in 2016, but progress has been very limited since then. - The infringement procedures initiated by the EC in 2015 regarding the minimum compulsory tariffs of architects and engineers were deferred to the European Court of Justice in 2017. ### Authorities’ views on entrepreneurship, digitalization, and energy - Authorities highlighted ongoing initiatives to support entrepreneurship and education; less concerned about declining trend of new business creation, viewing it as possible reflection of strong labor market conditions. - Authorities indicated funding for early-stage startups was adequate and funding environment for growth-stage improved, though large deals remain rare. - Scope exists for reducing administrative burden through simplifying procedures and providing more government services via electronic platforms. - Digital agenda and transition to renewable energy: - Government reiterated goal to make Germany a lead market for 5G application by 2025. - One main impediment to faster adoption of digital technology is lack of skilled labor; plans to enhance promotion of digitalization and ICT competences in SMEs, including regional advisory competence centers. - Authorities acknowledged cross-country comparisons suggest Germany lagging in connectivity, download speed and ICT density, but argued comparisons may mismeasure quality and product sophistication. - Authorities agreed pace of reforms in some professional services was slow but many existing regulations could be justified by concerns about quality and consumer protection. ### Housing market: risks, policies, and data gaps - Staff analysis: house prices have risen faster than can be explained by demand and supply fundamentals in major cities; aggregate-level rise moderate but double-digit rates in some hot spots. - Drivers of housing demand: rising household income, large immigration flows in recent years, low interest rates. - Supply constraints: stringent zoning restrictions (including for environmental protection), high and rising capacity utilization (including labor shortages) in construction sector. - House prices most overvalued in Munich, Hamburg, Hannover, and Frankfurt; estimated to be more than 20 percent above their fundament level on average in major German cities (Annex IX). - Bundesbank obtains similar overvaluation estimates for some German cities in its latest assessment. - Policy recommendations: - Lower the effective burden of tax on new construction. - Re-examine zoning restrictions, particularly where demand is not likely to abate. - New housing policies and measures: - Government foresees spending €2 billion in renewed support for social housing in 2020–21. - Plans to expand land available at a discount for social housing construction. - Creating tax incentives to build on unused land. - Plans to allocate €2 billion to families with children acquiring a first home. - The subsidy amounts to €1200 per child per year, in the first 10 years after purchased, for families with combined annual income no higher than the sum of €75,000 and €15,000 per child. - Staff assumes a total cost of €2 billion over 2018–22. - Other contemplated measures: tax subsidies for rental housing, public loan guarantees, real estate tax exemptions to reduce equity requirements for owner-occupied houses, strengthening rent controls. - Expected impact: measures have counteracting effects on supply and demand; overall impact on housing prices likely to be small. - Mortgage and household leverage: - Housing loans have grown only marginally faster than GDP in recent years. - Household debt stood at 53 percent of GDP at end-2017. - Overall debt-service-to-income ratio is low and declining. - Mortgage lending spreads compressed due to high competition among banks; mortgage credit is recourse and based on fixed interest rates. - Data gaps and macroprudential recommendations: - Absence of regional credit statistics and granular loan information prevents full assessment of financial stability risks in specific market segments. - Data gaps should be urgently addressed. - Macroprudential toolkit strengthened in 2017: loan to value (LTV) caps and amortization requirements legally created. - Income-based instruments (debt-to-income ratio and debt-service-to-income ratio) are not included in the legislation and should be added. - Given rapidly rising house prices in some cities alongside data gaps, early activation of macroprudential tools should be considered to prevent build-up of vulnerabilities. - If vulnerabilities are not present, measures such as LTV caps and amortization requirements would not likely be binding. ### Financial sector policies: profitability, risks, and regulatory changes - Banking sector profitability pressures: - Large German banks underperform relative to European peers, with relatively low return on equity due to high operating costs, outdated IT systems, provisions for compliance violations, and legacy costs from shipping exposure. - Leverage ratios improved somewhat in most large banks in 2017 but remain a relative weakness for some. - One German G-SIB presented an updated restructuring strategy to refocus activities in Europe and reduce personnel costs by shrinking its investment banking business; remains under supervisory scrutiny. - Small and medium-sized banks: low interest environment and strong competition in a highly fragmented market weigh on net interest margins; high operational costs dent profitability despite consolidation (number of bank branches declined by over 10 percent since 2013 for savings banks and cooperatives). - Capital and asset quality: - Risk-weighted capital stood at comfortable levels, supported by favorable macroeconomic conditions and declining risk weighted asset density, and is improving for all categories except large banks. - Non-performing loans (NPLs) continue to decline overall; provisioning for impaired shipping loans is leveling off. - Regulatory changes and implications: - Completion of Basel III: 72.5 percent “output floor” aimed at limiting effects on bank capital of sharp re-assessments of risks; will affect mostly large banks that use internal models. - Extensive phase-in period through 2027 for the output floor—affected banks should use it to de-risk portfolios and adapt business models. - Markets in Financial Instruments Directive (MiFiD) II came into force in January 2018—aims to increase transparency and efficiency but may add compliance costs for larger banks. - EU’s 2017 MREL policy sets targets binding only for larger/more complex banks in the Single Resolution Board remit; smaller and medium-sized institutions not yet affected. - Life insurance sector: - Low interest rates and Solvency II force restructuring in the life insurance sector. - Average investment yields trending down, catching up with (long term) guaranteed returns. - Life insurers shifting gradually away from guaranteed-return products to more flexible ones; transition lags European peers and guaranteed-return products expected to remain dominant through the next decade. - Solvency ratios improved alongside increase in long-term yields since late 2016, but majority (some 70 percent) of life insurers rely on transitional measures to calculate solvency capital requirement. - Bundesbank noted 14 life insurers would not meet the Solvency II minimum requirement as of end of 2016 without transition measures. - Priorities and supervisory recommendations: - Accelerate restructuring, restore profitability, and reduce interest rate risk in banking and life insurance sectors. - More aggressive cost cuts across banking industry; faster implementation/completion of restructuring plans for large banks. - For savings and cooperative banks: consolidation and development of further fee-based revenues. - For all banks, net interest margins expected to remain under pressure, especially for small and medium-sized ones. - Continued supervisory attention to interest rate risk and implementation of restructuring plans, including through Pillar II measures, remains essential. - Bundesbank and authorities’ views: - Financial market stress assessed to be low; capital buffers in banking and life insurance sectors deemed comfortable. - Early activation of borrower-based macroprudential tools deemed unjustified at this stage and would face legal obstacles. - Authorities share staff’s concern over information gaps that prevent fuller assessment of risks; microprudential tools are available and can be used to address bank-specific concerns. - Few banks expected to face funding shortfalls to meet MREL target; subordination requirements facilitated by recent changes to the German Banking Act. - Interest rate sensitivity of some German significant institutions remains slightly elevated. - Authorities take comfort in long transitional period through 2031 for reliance on transitional measures in Solvency II. ### Staff appraisal and outlook - German economy performing well with short-term outlook for continued robust growth, supported by solid consumption, investment, and exports. - Growth expected to revert toward long-term potential, limited by unfavorable demographics and still-low productivity growth. - Headline and core inflation still low but expected to pick up, reflecting tight market conditions. - Risks tilted to the downside: rise in protectionism, geopolitical uncertainty, or reassessment of sovereign risk in the euro area could negatively affect export prospects, weigh on investment, and rekindle financial stress. - Domestic risk: lack of progress in revamping bank business models could lead to financial distress in major banks. *International Monetary Fund — excerpt from CR18208 chapter* ### 49. The unemployment rate has reached post-reunification lows, resulting in a welcome ### 49. The unemployment rate has reached post-reunification lows, resulting in a welcome ### Labor market, wage growth, and inflation - The unemployment rate has reached post-reunification lows, resulting in a welcome rise in wage growth. - Further rises in wage and price inflation would help lift inflation in the euro area and facilitate the normalization of monetary policy. - The authorities could usefully emphasize this in their public communications, while respecting the autonomy of the social partners. ### External position and current account (paragraph 50) - The current account surplus remained very high in 2017, at 8 percent of GDP, reflecting positive net savings by households, non-financial corporations, and the general government. - Based on current policies and higher projected demand in trading partners, the current account surplus is expected to remain high, especially in the near term, before declining by ¾ percentage point of GDP by 2023. - Staff assesses the external position to be substantially stronger than implied by medium-term fundamentals and desirable policies. ### Fiscal position and public debt (paragraph 51) - The general government surplus rose to 1.2 percent of GDP in 2017—its highest level since reunification—on the back of favorable cyclical tax revenues and a declining interest bill. - In 2018, fiscal policy at the general government level is expected to be mildly expansionary, reflecting already-budgeted increases in spending on health and families, as well as a moderate increase in public investment. - The impact of the measures outlined in the new government’s coalition agreement is expected to be marginal in 2018, but would lead to a moderate fiscal stimulus in the following years. - Even taking into account these measures, the public debt ratio is expected to decline to well below 50 percent of GDP by 2023, preserving Germany’s substantial fiscal space within the European rules. ### Long-term challenges and coalition agreement measures (paragraphs 52–53) - Demographics and labor force - Germany’s demographic outlook remains unfavorable and the labor force is expected to begin shrinking already in 2020 even after accounting for immigration. - Productivity and investment - Productivity growth has been lackluster, especially in the service sector, and investment growth has been low. - Labor market participation and taxes - Germany’s high labor tax wedge creates disincentives to work; about half of women work only part-time despite relatively high female labor force participation. - Coalition agreement measures noted as welcome steps: - Planned expansion of high-speed internet and the 5G network to improve digital infrastructure. - Phasing out of the solidarity tax surcharges for low- and middle-income households to reduce the labor tax wedge moderately. - Plans to invest in all-day childcare and all-day schooling to make it easier for women to work full-time. - Initiatives to continue and expand housing and training for refugees to help integrate them into the labor force. - Additional modest support and incentives for schools, vocational training, and R&D activities. - Targeted social benefit increases—such as the supplementary allowance to combat child poverty and additional support for the long-term unemployed—would help reduce poverty risks. ### Policy action to boost domestic investment and support rebalancing (paragraph 54) - Use fiscal space to raise public investment and address municipal bottlenecks: - Actively promote PD’s services to municipalities where public investment has been delayed the most and address staffing shortages. - Further expand childcare and after-school programs to provide greater opportunities for women to pursue full-time employment. - Further reduce the labor tax wedge to reduce disincentives to work. - Provide additional funding for primary education and life-long learning to enhance skills in today’s and tomorrow’s workforce. - To accelerate investment in transport, the Federal Transport Agency should be operationalized without delay. - Pension and labor market reforms: - Make it more attractive to extend working lives to reduce the need to save, lower the public pension bill, and raise growth. - Sustain future pension replacement rates at levels consistent with a reduced risk of old-age poverty with less budgetary support. - Improve transparency of future pension payouts at the household or individual level to reduce uncertainty and household precautionary savings. - Foster entrepreneurship and venture capital: - Improve access to venture capital, especially at growth stages for new companies. - Support investment in intangible assets. - Simplify tax administration and provide tax incentives for R&D to small- and medium-size enterprises. - Expand e-government services to reduce administrative burdens. - Digital infrastructure: - Implement the new government’s plans to expand the nationwide fiber optic network without delay. - Ensure incentives, regulations, and funding availability appropriately support digital transformation. - Product market competition: - Introduce greater competition in network industries and professional services to raise productivity growth and promote private investment. - Accelerate progress where limited. ### Housing market and macroprudential policy (paragraphs 55–56) - House prices - House prices remain in line with fundamentals at the aggregate level but appear overvalued in some major cities. - Given recent immigration, rising incomes, and the low interest rate environment amid supply constraints, some growth in house prices is to be expected. - In some large cities, house price growth seems stronger than warranted by these fundamentals. - Supply measures - The government has committed funds to increase social housing. - Additional measures are needed to expand supply, including reconsidering zoning restrictions or reducing the effective tax burden on new construction. - Data gaps and macroprudential toolkit - The lack of granular data prevents a full assessment of developments and must be addressed. - The creation of macroprudential tools focused on real estate—loan-to-value (LTV) and amortization requirements—in 2017 was a welcome step. - These tools should be complemented with income-based instruments. - Consideration should be given to early implementation of supervisory measures, including LTV caps or amortization requirements, to help preserve financial stability. ### Banking and insurance sector restructuring (paragraph 57) - Banking sector - The regulatory capital ratio has increased, but the cost-to-income ratio and leverage remain high. - High cost structure, low net interest margins, and provisions for compliance violations continue to weigh on profitability. - Restructuring is ongoing but must be accelerated through faster implementation of restructuring plans, continued development of fee-based income, and further consolidation. - Life insurance sector - Low interest rates have dented solvency ratios; further progress is needed to reduce reliance on guaranteed return products. - Supervisory attention - Continued supervisory attention to progress in implementing restructuring plans and interest rate risk both in banking and insurance is essential. *GERMANY INTERNATIONAL MONETARY FUND* ### 58. It is recommended that the next Article IV consultation take place on the regular ### 58. It is recommended that the next Article IV consultation take place on the regular 12-month cycle. ### Growth Developments - German economy remains on an uptrend; both domestic demand and foreign balance contributed to GDP growth in 2017. - Contributions to quarterly GDP growth (Demand Components): charts indicate domestic demand and foreign balance variations over 2012Q1–2018Q1 (visual detail preserved in source). - Indicators: - Employment (2008Q1=100) trending up through 2018Q1. - Capacity utilization: Industry and Construction above historical averages (2007Q1–2018Q1). - Business survey results (PMI manufacturing/services; Ifo Business Expectations) retreated from recent highs. - Selected economies: Real GDP (2008Q1=100) shows Germany and Rest of EA series through 2018Q1. ### Prices and Labor Market - Inflation contributions (year-over-year percent change): - Energy, Food, alcohol, and tobacco, Core components shown for Jan-12 to Jan-18. - Labor market: - Job vacancy rate and real employee compensation (Y-o-y growth) presented (2000Q1–2016Q1). - Employment and unemployment: Employment index (2008Q1=100) and unemployment rate (%) shown. - Key qualitative points: - Inflation temporarily ebbed due to a lower contribution of oil and food prices. - Unit labor costs rose, helping to normalize the labor share. - Working age population would drop quickly if net immigration flows subside (Destatis projections scenarios shown). - Labor market tightness should boost wage pressures. - Wage and productivity: - Nominal compensation per employee (y-o-y growth) and labor share charts indicate nominal wage growth has remained above productivity growth. - Working-age population projections (Millions aged 15-74) show scenarios from 2020–2060 (most pessimistic to most optimistic). ### Balance of Payments and External Sector - Net International Investment Position (NIIP) reached 60 percent of GDP (end-2017). - Current Account (CA) developments: - CA edged down in 2017 relative to previous year. - CA balance breakdown (percent of GDP) and by region charts for 2000–2017. - Rising net lending by corporates and government underpinned upward trend in CA. - Financial flows: - External savings financing a net increase in portfolio investment; direct investment edging down. - Capital and financial account contributions by instrument shown (2000–2017). - REER: - CPI-based and ULC-based REER (2010M1=100) appreciated in 2017 in line with euro strengthening. - Sectoral saving-investment balances and capital/financial account charts presented. - Specific observed values (Table and charts): - Target2 claims on the Eurosystem surpassed €956 billion in May 2018 (28 percent of GDP). - REER appreciation through May 2018 about 2 percent relative to 2017 average (estimate). - NIIP composition: financial corporations other than MFIs NIIP positive 57 percent of GDP; general government NIIP negative 25 percent of GDP. ### Current Account: Background, Assessment, and Quantitative Estimates - Background: - CA surplus widening since 2001; averaged 7.9 percent of GDP over the last five years; peaked at 8.9 percent of GDP in 2015. - In 2017 CA was 8.0 percent of GDP. - Net exports fell for first time in 6 years due to worsening terms of trade. - Bulk of CA surplus reflects large saving-investment surpluses of non-financial corporations (NFCs) and households; rising NFC savings and fiscal consolidation contributed. - Assessment (2017): - Cyclically-adjusted CA balance reached 8.3 percent of GDP in 2017. - Staff CA norm assessed at 2–4½ percent of GDP, with a midpoint ½ percent of GDP above the CA norm implied by the new EBA model of 2¾ percent. - Quantitative summary (as reported): - Actual CA: 8.0 - Cycl. Adj. CA: 8.3 - EBA CA Norm: 2.8 - EBA CA Gap: 5.5 - Staff Adj.: 0.5 - Staff CA Gap: 5.0 ### Real Exchange Rate (REER) Assessment - Background: - Yearly average CPI-based REER appreciated 1½ percent in 2017. - Yearly average ULC-based REER appreciated ½ percent in 2017. - Nominal euro appreciation versus British pound, yen, US dollar, yuan, Swiss franc contributed; relative pick-up in inflation and labor costs also contributed. - Assessment: - Staff’s 2017 assessment: REER undervaluation of 10–20 percent. - Refined EBA REER Level model yields an undervaluation of 14 percent. - Undervaluation implied by CA gap using standard trade elasticities: 15–30 percent. ### Fiscal Developments and Outlook - General government: - General government surplus reached a historical high in 2017. - Fiscal surpluses expected to push debt down to 45 percent of GDP by 2023 (staff projection chart). - Fiscal policy expected to be expansionary over 2018–21. - Public investment picking up from a low base. - Table highlights (Table 1 and Table 2): - GDP growth: 2015: 1.5; 2016: 1.9; 2017: 2.5; 2018: 2.2; 2019: 2.1. - General government overall balance (billions of euros): 2015: 25.4; 2016: 31.9; 2017: 38.2; 2018: 46.7; 2019: 49.8. - Overall balance (percent of GDP): 2015: 0.8; 2016: 1.0; 2017: 1.2; 2018: 1.4; 2019: 1.4. - General government debt (billions of euros): 2015: 2,161.8; 2016: 2,145.5; 2017: 2,092.6; 2018: 2,034.5; 2019: 1,974.7. - Debt (percent of GDP): 2015: 71.0; 2016: 68.2; 2017: 64.1; 2018: 60.0; 2019: 56.1. - Fiscal composition (Table 2, percent of GDP projections 2015–23): - Revenue: ranges 44.5 (2015) to 44.8 (2023, projection). - Expense: 43.7 (2015) to 44.0 (2023, projection). - Gross public investment ~2.1–2.4 percent of GDP across 2015–23. - Net lending/borrowing: 0.8 (2015) to 0.7 (2023) percent of GDP. ### Credit Conditions and Asset Prices - Lending rates on new loans to non-financial corporations shown by country (Germany, France, Italy, Spain). - Lending by monetary financial institutions: - Contribution from loans to households and NFCs in Y-o-Y growth; pickup in NFCs’ contribution to credit growth observed. - Bank lending survey: - Slightly looser lending standards and higher demand for corporate credit; change in credit demand by enterprises net percentage series shown through Mar-2018. - Asset prices and yields: - German government bond yields remain very low; 10-year bond yield noted as of June 12, 2018 (chart scale). - German equities (DAX) continue to outperform EURO STOXX 50 (2007M1=100 index). ### Banking Sector: Recent Developments and Soundness Indicators - Investor sentiment toward Deutsche Bank deteriorated again. - Two largest banks trading at a discount to European peers; low profitability reflecting high costs and low interest rate margins. - Capital and leverage: - Phase-in Common Equity Tier 1 ratios by bank for 2016 vs 2017 show improvements for several banks (chart). - Leverage ratios generally higher than European peers; specific leverage ratios (percent) by bank shown (2016–2017). - Profitability: - Return on assets and return on equity (after-tax) series show low profitability for many large banks. - Core financial soundness indicators (Table 6, 2012–17): - Regulatory capital to risk-weighted assets (percent): 2012: 17.9; 2013: 19.2; 2014: 18.0; 2015: 18.3; 2016: 18.8; 2017: 19.4. - NPLs to gross loans (percent): 2012: 2.9; 2013: 2.7; 2014: 2.3; 2015: 2.0; 2016: 1.7 (trend by bank category provided). - Return on average assets (after-tax) around 0.2 percent for aggregate banking sector across 2012–2017. ### Housing Market Developments - Residential rents and housing prices (index, 2008=100): residential rents (new contracts, old buildings), disposable income per household, and price of owner-occupied apartments increased since 2010. - Net immigration: - Net immigration forecast versus actual, 2009–2017: actual surge in immigration noted; forecasts from 2009 and 2015 (low/high migration) compared. - Real estate supply indicators (March 2018): housing permits, residential construction orders, investment in residential construction (% of RGDP) (Index, 2015Q1=100). - New residential housing units (thousands) vs needs pre- and post-refugee surge indicated. - Observations: - Residential prices and rents rising faster than income since 2010. - Residential investment slowed in 2016–17, suggesting capacity constraints and adding to a demand backlog. - Total transaction values trending up; number of transactions stable since 2011. - Table highlights (Table 7 Real estate indices, 2011=100 and 2010=100): - Real estate prices, new dwellings index: 2011=100; 2017: 153.6. - Real estate prices, resale index: 2017: 155.6. - Residential real estate loans to total loans (percent): 2012: 16.7; 2017: 18.6. ### Product Market Competition, Innovation and Digitalization - Sectoral labor productivity growth (average annual growth of gross value added per hour worked, 2011Q4–2017Q4): ICT and Information & communication sectors show relatively higher productivity growth; non-financial non-ICT services have had low productivity gains. - Germany is an innovation leader by EU Summary Innovation Index, but exhibits relative weakness in venture capital (EU Venture Capital index 2014–2016). - ICT capital per worker low relative to other advanced economies (1995–2015). - Internet access and connection speed (2017Q1): average connection speed and IP addresses per population low versus some peers (charts). - Professional regulation: charts show some professions have higher entry requirements/regulatory restrictiveness compared to E.U. median and peers. ### Key Economic Indicators and Projections (Selected Figures) - Table 1 selected lines (2015–2019): - GDP growth: 2015: 1.5; 2016: 1.9; 2017: 2.5; 2018: 2.2; 2019: 2.1. - Unemployment rate (percent): 2015: 4.6; 2016: 4.2; 2017: 3.7; 2018: 3.6; 2019: 3.5. - CPI (harmonized): 2015: 0.1; 2016: 0.4; 2017: 1.7; 2018: 1.8; 2019: 1.7. - Compensation per employee (total economy): 2015: 2.6; 2016: 2.2; 2017: 2.6; 2018: 3.3; 2019: 3.5. - Balance of payments highlights (Table 4 projections 2015–23): - Current account (percent of GDP): 2015: 8.9; 2016: 8.5; 2017: 8.0; 2018: 8.3; 2019: 8.1; 2020: 8.0; 2021: 7.9; 2022: 7.7; 2023: 7.6. - Exports (percent of GDP): 2015: 38.7; 2016: 37.9; 2017: 38.9; 2018: 39.4; 2019: 40.0. ### External Position: Overall Assessment and Policy Implications - Overall Assessment: - Germany’s external position in 2017 remained substantially stronger than implied by medium-term fundamentals and desirable policy settings. - Staff projects a modest narrowing in the medium run, supported by gradual realignment of price competitiveness and continued strong domestic demand. - As part of the euro zone, the nominal exchange rate does not flexibly adjust; stronger wage growth relative to euro area trading partners expected to contribute to realignment within the monetary union. - Projected adjustment is partial; additional policy actions will be necessary for further progress on external rebalancing. - Potential policy responses: - Adopt a more growth-oriented fiscal policy that uses fiscal space to stimulate potential growth. - Implement structural reforms to foster entrepreneurship. - Pursue pension reforms prolonging working lives to reduce saving needs for retirement, stimulate investment, and reduce external imbalances. *International Monetary Fund. Content unit: cr18208 - 58.* ### Annex I. External Sector Assessment ### Annex I. External Sector Assessment ### Overall Assessment - Safe haven status and the strength of Germany’s current external position limit risks. ### Capital and financial accounts: flows and policy measures - Background: - In 2017, net portfolio flows constituted almost ¾ of the capital and financial accounts balance, with direct investment being the second largest item (1/6 of total). - On a regional basis, over ⅔ of the net outflows were toward European countries and 10 percent toward the Americas (mostly the U.S.). - 80 percent of net inflows in 2017 originated from the EU, while net investment by emerging countries has picked up considerably, representing about 40 percent of total. - Net direct foreign investment inflows and outflows recovered to historical highs, after a drop in 2016, coming/going mostly from/to euro area countries. - Assessment: - Safe haven status and the strength of Germany’s current external position limit risks. ### FX intervention and reserves level - Background: - The euro has the status of global reserve currency. - Assessment: - Reserves held by Euro area countries are typically low relative to standard metrics. The currency is freely floating. ### Technical Background Notes - Note 1: - Demographic factors have a lower contribution to the EBA CA norm than previously estimated (¾ percentage points of GDP, instead of the previously estimated 3 percentage points of GDP), due to demographic projection updates and model refinements. - Moreover, for Germany, nearly all of the EBA-estimated gap for 2017 reflects the regression’s residual rather than gaps in the policies variables included in the EBA model. - Note 2: - The estimated norm reflects changes in the credit gap estimates to better reflect the German financial cycle. - Staff assesses the credit-to-GDP to be currently lower than its long-term equilibrium, and that gradually closing of such gap will help support investment over the medium term. - Note 3: - The EBA REER Index model implies that the REER is close to equilibrium. However, the EBA REER Index model has an unusually poor fit for Germany. *Source: IMF staff (Annex I. External Sector Assessment).* ### Annex IV. Authorities’ Response to Past IMF Policy ### Annex IV. Authorities’ Response to Past IMF Policy ### Fiscal Policy - IMF recommendation: Fiscal space should be used to raise the growth potential by encouraging investment, promoting labor supply, and boosting productivity. - IMF recommendation: Re-examine revenue projection models to improve fiscal planning. - IMF recommendation: Implement pension reforms to make it more attractive to extend work lives. - Authorities’ response: - The new government’s coalition agreement includes measures to support long-term growth: a package of €46 billion in additional spending (investment in schools, vocational training, and R&D activities) and tax cuts, spread over the next four years. - An additional fund (financed by auctioning 5G licenses and tax revenue overperformance) will be created for the expansion of the high-speed internet network. - Almost 90 percent of the first tranche (€3.5 billion) of the government’s Municipal Investment Promotion Fund (MIPF) created in 2015 has been earmarked as of June 2017. - Partnerschaft Deutschland (PD) is providing advisory services on planning and procurement to an increasing number of public investment projects at the municipality level. - No new action taken on re-examining revenue projection models. - No new action taken on pension reforms to make it more attractive to extend work lives. ### Financial Sector Policy - IMF recommendation: Expand the macroprudential toolkit to better address potential future excesses in the housing sector. - IMF recommendation: To partially overcome data gaps, conduct a regular survey in hotspots to assess households’ leverage, loan affordability, and the concentration of bank exposure. - Authorities’ response: - No new macroprudential regulation was adopted since publication of the 2017 Article IV Staff Report. - There are no new initiatives for collection of supervisory data. - For progress on the implementation of outstanding FSAP recommendations, see Annex V. ### Structural Reforms - IMF recommendation: Anti-poverty policies should seek to preserve the strong gains in labor force participation and employment of the past decade. - IMF recommendation: Consider pension reforms that make it attractive to extend working lives. - IMF recommendation: Pursue competition-enhancing reforms in professional services and network industries. - Authorities’ response: - No new action taken on anti-poverty policies. - No new action taken on pension reforms. - Professional services: No action taken in Germany. The EC presented the final report on the action plan to complete the transparency initiative for regulated professions. - Network industry: National implementation of the Directive establishing the European Electronic Communications Code is envisaged within the next 12 months. ### Digitalization, Innovation, and Venture Capital - IMF recommendation: Advance digitalization. - IMF recommendation: Continue to support innovation and venture capital, assess the effectiveness of government measures (e.g., the introduction of “Scale”), and address administrative uncertainties, including the treatment of value-added tax on management fees for venture capital. - Authorities’ response: - The Federal Government aims to roll out comprehensive gigabit networks through Germany by 2025. - The coalition agreement contains a plan to expand digital infrastructure (10–12 billion euro), with the Gigabit Investment Fund available for deployment of gigabit networks in rural areas. - The new government has political commitment to introducing R&D tax credit and further reducing administrative burden, including through expanding e-government service provisions. - Progress in improving the start-up ecosystem: operationalization of “High-Tech Gründerfonds III” in Germany and “VentureEU” in Europe, both targeting growth stages. - The number of companies listed at the “Scale” segment of Deutsche Börse has risen to 50, although it is too premature to assess the performance of this new segment. - Limited progress has been made in equalizing the treatment of value-added tax on management fees for venture capital within Europe. ### Annex V — Authorities’ Response to FSAP 2016 Recommendations (Selected items) - Financial stability policy framework - Recommendation: Establish a core set of readily-available, consistent data for banks and non-banks. - Status: The Bundesbank is integrating selected granular supervisory and statistical data of banks, insurance companies and investment funds to build a “house of microdata.” The “house of microdata” will be supplemented by AnaCredit data when available. - Recommendation: Develop the legal basis for real estate-related macroprudential tools. - Status: On March 30, 2017, the Bundestag passed legislation that entered into force on June 10, 2017, introducing instruments for capping LTV ratios and setting amortization requirements for financial stability purposes. The law omits complementary DTI and DSTI ratio instruments and does not address important data requirements. - Banking oversight - Recommendation: Implement measures to strengthen the oversight role of the banks’ supervisory board. - Status: Within the German two-tier system, the supervisory board’s role is passive and restricted; no indication the legislator intends to amend the legal framework. - Recommendation: Provide guidance on risk management and other supervisory requirements (loan portfolio management, concentration and related party risk, operational risk). - Status: Bundesbank and BaFin are following-up on 2016 FSAP recommendations when reviewing relevant provisions in MaRisk; authorities consider concentration risk sufficiently covered by MaRisk. - Recommendation: Increase granularity and coverage of bank supervisory data. - Status: Since June 2017, all LSIs have to report using FINREP templates, increasing granularity and comprehensiveness; national regulatory reporting remains in place as a necessary complement. - Recommendation: Increase the effectiveness of the AML/CFT supervisory framework over cross-border banks. - Status: As of 1 January 2017, BaFin’s AML Department added 30 additional staff (two new divisions for AML/CFT banking supervision). BaFin asked banks with cross-border correspondent banking relationships to emphasize this issue in their own risk assessments and participates in EBA work on supervisor colleges. - Insurance oversight - Recommendation: Prepare a communication strategy ahead of the publication of Solvency II indicators. - Status: BaFin conducted bilateral discussions with LI companies ahead of the publication date of May 21, 2017, but no common communication strategy was decided. - Recommendation: Extend the application of G-SII toolkit on a risk-based basis to other large groups. - Status: BaFin has extended the requirement for recovery plans to two other groups beyond the country’s single G-SII; does not currently intend to further extend this requirement. - Recommendation: Communicate supervisory expectations based on the ORSA review more systematically; use Solvency II framework to impose capital add-ons. - Status: BaFin gives feedback to firms following ORSA review and is ready to set capital add-ons on a case by case basis when pre-conditions under Solvency II are met. - Recommendation: Require action plans for companies facing difficulties in meeting Solvency II requirements. - Status: BaFin monitors progress towards compliance and assesses companies’ plans yearly; is reviewing internal models and developing a new stochastic approach (BSM—Branchensimulationsmodell). - Asset management oversight - Recommendation: Intensify frequency of on-site inspections and enhance risk classification methodology. - Status: BaFin revised the risk classification methodology and increased on-site inspections from 80 in 2014, to 102 in 2016 and 116 in 2017. - Recommendation: Introduce stronger rules on reporting of pricing errors and investor compensation rules. - Status: BaFin published the “Mindestanforderungen an das Risikomanagement von Kapitalverwaltungsgesellschaften” (KAMaRisk) in January 2017, requiring policies to inform depositaries of material pricing errors and to compensate investors in the event of material pricing errors. ### VI. Puzzling Wage Developments in Germany? — Key Findings - Main conclusion: The standard wage Phillips curve is alive and well in Germany, and there is no evidence that immigration has had a dampening effect on wage growth in recent years. - Context and puzzle: - GDP has been growing at a robust pace post-crisis; employment has been booming and the unemployment rate has reached record lows. - Wage growth has stabilized around 2.5 percent since 2012, prompting questions about the Phillips curve’s validity for Germany. - Role of Hartz reforms: - The Hartz reforms resulted in a one-time inward shift of the Beveridge curve: enhanced matching efficiency and lowered unemployment benefits pushed the NAIRU down. - A significant part of the decline in unemployment between 2005 and 2008 reflects a more efficient (not a tighter) labor market. - A traditional Phillips curve adjusted for the decline in the NAIRU fits German wage growth well; slope has remained constant. - Wage growth is well explained by deviations of past wages from trend labor productivity (error correction term), inflation expectations (forward and backward looking) and the unemployment gap. - Immigration and wages: - Theoretical/literature background: Immigration exerts downward pressure on wages of workers who are close substitutes and upward pressure where immigrants are complements; overall effect is an empirical question. - Stylized facts for 2012–2016 immigration wave: - Germany’s relative unemployment rate of foreign workers with respect to natives remained constant, suggesting a demand-pull story. - IAB social security panel data indicate migrants increased most in sectors where wage increases were the highest and where previous immigrant workers were already most active (Food and accommodation (I), Support (N), Transport (H) and Construction (F)), consistent with demand-pull dynamics. - In contrast, Spain’s immigration episode showed a sharp increase in foreign workers’ relative unemployment rate, hinting at supply-push factors. - Empirical approaches and results: - Aggregate approach: Estimated micro-founded Phillips curves allowing immigration to affect slope and intercept yielded immigration-related terms that are either insignificant or wrong-signed. - Micro-level approach: Using IAB social security data and a weighted least square panel over 2012–2016, a shift-share analysis of 14’760 clusters was constructed to disentangle composition from competition effects. Early results indicate composition effects matter because immigrants are paid less than natives (see following text in source for precise quantified outcome). *Source: Annex IV. Authorities’ Response to Past IMF Policy (cr18208).* ### 0.56 percent over the period 2012–2016, ### cr18208 - 0.56 percent over the period 2012–2016, ### Immigration and wage dynamics: composition effect - Pure accounting (composition) effect of immigration over 2012–2016: - 0.56 percent (or 0.14 percent per year) if the immigration boom had not taken place. - Composition channels contributing to the - 0.56 percent aggregate composition effect (Shift-Share Analysis: Composition Effect Broken Down, Percent): - nationality: -0.18 - sex: 0.02 - age: -0.05 - qualification: -0.02 - sector: -0.27 - job/working time: -0.08 - region: 0.02 - total: -0.56 - Specific attributes of the migrant population accounting for parts of the negative composition effect: - immigrants are relatively young: -0.05 percent - immigrants work part-time: -0.08 percent - immigrants are employed in sectors that pay less: -0.27 percent - Even controlling for these factors, immigrants are paid less than natives, bringing aggregate wages down by -0.18 percent over the period. ### Immigration and wage dynamics: competition effect - Empirical finding (Table 2, first line): after controlling for lower immigrant wages and other observable factors, the marginal effect of the immigration measure on wages is positive. - Interpretation of coefficient: if the migrant share increased by one percentage point, overall wages would increase by 0.5 percent. - Observed yearly average increase in migrant share in total working population: 0.44 percentage points. - Resulting competition effect on aggregate wages: 0.22 percent per year. ### Aggregate impact on wages and Phillips curve evidence - Net effect (composition negative and competition positive): immigration had a negligible (and slightly positive) effect on aggregate wages over the last 4 years. - Relying on aggregate data only, the Phillips curve for Germany suggests no role for immigration in explaining recent wage dynamics. - Consistency with other findings: recent results from Weber and Weigand (2018) find no negative effects of immigration shocks on wages in a structural macroeconometric analysis. ### WLS panel wage equation (Table 2, Germany 2002–2016) — selected estimated effects (dependent variable: log wage; N=59,840) - migrant_intensity_t-1: 0.005 (S.E. 0.000) - German: 0.005 (S.E. 0.000) - Europe without EU: -0.042 (S.E. 0.004) - EU: -0.056 (S.E. 0.003) - 8 asylum countries: -0.148 (S.E. 0.012) - other migrants: -0.096 (S.E. 0.006) - male: 0.053 (S.E. 0.001) - female: -0.056 (S.E. 0.001) - age groups: - 15-25: -0.246 (S.E. 0.002) - 25-35: -0.081 (S.E. 0.001) - 35-45: 0.046 (S.E. 0.001) - 45-55: 0.091 (S.E. 0.001) - 55-65: 0.085 (S.E. 0.001) - over 65: -0.053 (S.E. 0.004) - qualification: - low: -0.196 (S.E. 0.003) - medium: -0.016 (S.E. 0.001) - high: 0.282 (S.E. 0.001) - sectoral effects (selected): - Manufacturing: 0.118 (S.E. 0.001) - Accommodation and food service activities: -0.313 (S.E. 0.004) - Financial and insurance activities: 0.281 (S.E. 0.003) - Administrative and support service activities: -0.248 (S.E. 0.003) - job/work time: - SVB+full-time: 0.333 (S.E. 0.001) - SVB+part-time: -0.183 (S.E. 0.001) - marginal: -1.058 (S.E. 0.003) - regional effects: - West: 0.030 (S.E. 0.000) - East: -0.140 (S.E. 0.001) - year fixed effects (selected): - 2013: 7.591 (S.E. 0.002) - 2014: 7.614 (S.E. 0.002) - 2015: 7.634 (S.E. 0.002) - 2016: 7.650 (S.E. 0.003) - Additional model statistics: - F(40, 59800) = 4604598.89 - Prob > F = 0.0000 - Root MSE = 0.0111 ### Annex VII — The rise of German non-financial corporate (NFC) savings: stylized facts and firm-level evidence - Main stylized facts: - NFC gross saving rates have risen over the last two decades; saving rates defined as a share of gross value added (GVA). - Weight of corporate GVA in GDP has risen, translating NFC saving rates into higher savings as a share of GDP. - Before 2007: rise in savings rates driven by rising profitability (wage moderation and declining interest payments). - After 2007: interest payments continued to fall; labor share in GVA recovered to 2001 levels; decline in dividend payout share from about 50-55 percent to less than 45 percent became the main driver of corporate savings. - Reinvested earnings from FDI picked up around 2001 and have been roughly constant since then. - Leverage and liquidity: - Debt-to-equity declined to about 50 percent (historical low). - Cash holdings and other liquid assets rose substantially; equity claims (largely related to FDI) increased after 2008. - Firm-level (Orbis) evidence 2004–2015: - Saving rate increase in Orbis sample: about 1.6 percentage points (compared with 2.2 percentage points in national accounts). - Average saving rate in Orbis sample about 2.7 percentage points lower than national accounts. - Contribution to gross NFC saving increased by about 13 percentage points for medium firms and 4 percentage points for small firms during 2004–2015. - Small firms exhibited the largest increases in saving rates; large firms’ saving rates were stable. - Family-owned small firms have the highest saving rates, driven by low interest payments and increasing operating surpluses. - Deleveraging at firm level: - Debt-to-equity ratios decreased across all firm-size groups by an average of 27 percentage points during 2004–2015. - Small firms’ leverage dropped by 34 percentage points, to 54 percent in 2015. - Deleveraging achieved through debt reduction with small increases in equity positions. - Cash holdings and ownership: - Cash holdings (percent of total assets) of family-owned firms increased from 9 percent in 2004 to 15 percent in 2015. - Cash holdings of non-family-owned firms stayed around 5 percent over the same period. - High and increasing cash holdings of family-owned firms not associated with high or increasing intangible assets. - Potential drivers of higher NFC savings (enumerated): - 2000 corporate tax reform: more favorable tax treatment of retained earnings, aimed at supporting debt reduction. - 2008 reform reduced corporate tax rates and limited interest deductibility. - Precautionary motive after the GFC due to experience of tight financial conditions. - Decline in interest rates may explain decline in dividend payout ratio if equity investors expect a constant risk premium over risk-free assets. - Possible relation between dividend policy and corporate governance quality; declining dividends may relate to deteriorating perceptions regarding protection of minority shareholders rights. - For family-owned firms, lower pressure to pay dividends due to blurred distinction between household and firm saving. *International Monetary Fund — cr18208 - 0.56 percent over the period 2012–2016,* ### Annex VIII. Government Investment in Germany ### Annex VIII. Government Investment in Germany ### Overview - At around 2 percent of GDP, Germany’s general government investment is among the lowest in advanced economies. - Cross-country comparison is complicated by government-supported investment that is not counted as government investment (examples include investment grants, public-private partnerships (PPPs), loan guarantees, and tax concessions). - Given data limitations, the analysis also examines total—public and private—investment in areas where government indirect support can be sizable. ### Evolution of General Government Investment in Germany - General government investment declined from around 3 percent of GDP per year in the early 1990s to 2–2¼ percent of GDP per year in recent years. - The decline after reunification and the shift of activities to the private sector (e.g., outsourcing, privatizations) especially at municipalities (waste and sewerage management, water supply) and Länder (universities) contributed to the decline. - The reduction was most prominent in municipal spending on construction; the cut in investment between 1993–95 (just after reunification) and 2009–11 was larger in Länder with higher debt in the mid-1990s. - The decline in investment between 1995–2004 and 2012–16 was larger in municipalities with higher debt. - Surveys indicate roughly one third of municipalities—notably those that are highly indebted—have seen a decline in loan offers, particularly for high volumes and long maturities. - Recent financial relief and investment promotion by the federal and Länder governments have been supporting municipal investment. - Reductions in municipal staff over years, especially in construction and planning sectors, have created capacity constraints. ### Net Capital Stock and Investment Backlogs - The general government’s net capital stock—gross capital stock net of depreciations—has been stagnant since 2000. - Declines in dwellings and non-dwelling buildings—whose shares in total net capital stock were 2 percent and 85 percent, respectively, in 2016—were largely offset by rapid rises in intellectual properties and machinery over the last decade. - Municipalities’ net capital stock has declined since the early 2000s, returning to the level around reunification; federal government and Länder net capital stock have risen. - KfW (2017) survey: municipalities’ perceived investment backlog stood at €126 bn (3.9 percent of GDP) in 2017, with traffic infrastructure accounting for 27 percent of the backlog and education including schools accounting for 26 percent of the backlog. ### Cross-Country Comparison of General Government Investment - Various modalities for government support to investment (investment grants, PPPs, loan guarantees, tax concessions) complicate cross-country comparison and are difficult to integrate consistently due to data limitations. - General government investment including investment grants in Germany was around 3 percent of GDP annually during 2012–16, about 1 percent of GDP below that in peers. - The German government has provided substantial loan guarantees, some of which support investment in public services. - Certain public services (e.g., education, healthcare) are provided by the private sector in Germany while in other countries they are provided by the public sector, further complicating comparisons. ### Total—Public and Private—Investment - Germany’s total investment—including both private and public—has been below peers’. - Focusing on non-dwelling investment, Germany trails peers, especially in buildings and structures (which include roads, railways, and ports). - Investment in equipment and other assets (e.g., intellectual properties) is comparable to peers. - The net capital stock of key infrastructure—utilities and land transport service—has been on a declining path since the early 2000s. - The perceived quality of overall infrastructure (World Economic Forum’s Executive Opinion Survey) is relatively high for Germany compared to other advanced economies, but the score for Germany has been deteriorating since the global financial crisis, from close to the best performer to closer to the median performer. ### Human Capital Investment - The German government has been spending around 4¾ percent of GDP in education and active labor market programs in recent years, compared with 6–6½ percent of GDP in other advanced EU countries. - The private sector plays a significant role in the German education system (“Freie Träger”), so focusing only on government education spending can be misleading. - Total—public and private—education spending per student also suggests low education spending in Germany, especially for primary education, when controlling for income differentials among advanced economies. - Education outcomes, as measured by PISA score for mathematics, are relatively high, suggesting sound spending efficiency. - Regional disparities are rising, reflecting socio-economic variations, and the decentralized education system makes it difficult to ensure certain standards in core subjects across Länder. - The net capital stock of buildings in the education sector has been stagnant since the late 1990s, consistent with municipalities’ perceived investment backlog in education. ### Key Findings - Germany’s general government investment has declined since reunification, driven by construction spending cuts at municipal level. At around 2–2¼ percent of GDP, Germany’s general government investment is among the lowest in advanced economies. - Different modalities of government support (investment grants, PPPs, loan guarantees, tax concessions) complicate cross-country comparisons. Accounting for investment grants and PPPs, Germany’s general government investment remains below peers’; the government also provides sizable loan guarantees, some of which may be used for investment in public goods. - Germany’s total—private and public—investment in non-dwelling assets is below peers’, especially in buildings and structures. The net capital stock of infrastructure (e.g., land transport, utilities) and education has been eroding since the early 2000s. The perceived quality of infrastructure is deteriorating while municipalities’ perceived investment backlog for education and infrastructure is accumulating, suggesting scope for increasing investment in these areas. *Prepared by Laurent Kemoe and Aiko Mineshima; sources include Destatis, Haver Analytics, KfW (2017), Federal Ministry of Education and Research (BMBF, 2016), Eurostat, IMF “FAD Investment and Capital Stock Database, 2017,” AMECO, OECD, and IMF staff calculations.* ### 6. Existing empirical studies on house price valuations mainly focus on country-level ### 6. Existing empirical studies on house price valuations mainly focus on country-level ### Summary of prior studies - Existing empirical studies mainly analyze country-level developments rather than city-level prices. - Conclusions regarding Germany at the aggregate level generally indicate no build-up of risk in the German housing market. - Dermani, Lindé and Walentin (2016) and Geng (2018) show that fundamentals would warrant higher house prices in Germany. - Kajuth, Knetsch and Pinkwart (2016) compared actual house prices to fundamental prices for a number of German cities/regions and found that prices of both apartments and single-family homes significantly exceeded fundamentals in major cities. - The Bundesbank, based on Kajuth et al. (2016), estimates that house prices in Germany’s “hot spots” may be overvalued by as much as 30 percent in 2017. ### City-level housing valuation model — methodology - The report revisits valuation using a housing valuation panel model at city level for the 10 biggest German cities and 12 large European cities to allow a more precise assessment of imbalances at the relevant aggregation. - Fundamental house prices are derived from an estimated long-run relationship between city/country demand and supply shifters and actual city-level house prices. - Notation (as in source): - ܲ௜௧, ܲ௜௧∗ and ߝ௜௧ denote actual house price, fundamental house price and deviation of house price from fundamentals (housing valuation gap) in city ݅ at time ݐ respectively, so that ܲ௜௧ ܲ = ௜௧∗ ߝ ൅ ௜௧. - Fundamental specification (as in source): ܲ௜௧∗ ߙ = ௜ ߚ ൅ ௗ ܦ௜௧ ߚ ൅ ௦ ܵ௜௧ where ߙ௜ is a city-specific effect, and ߚௗ (resp. ߚ௦) is a vector of demand (resp. supply) elasticities of the fundamental house price. - House prices are introduced in logs; ߝ௜௧ = ܲൌ௜௧ ܲെ௜௧∗ is the percent deviation (housing valuation gap). - Demand shifters (ܦ௜௧) include country-level real mortgage interest rates and city-level real GDP per capita (real household income proxy), population density, and annual percentage change in employment rate. An interaction term between a fixed-rate dummy and the mortgage rate is included to account for cross-country mortgage contract differences. - Supply shifters (ܵ௜௧) include city-level construction prices and a two-year lag of real investment in real estate activities as a proxy for changes in housing stock. - Robustness analyses explore policy/institutional/structural factors (rent controls, tax relief for housing purchases, long-run supply responsiveness) by extending the specification with ܫ௜௧ and ߚ௜. ### Data and sample - House price and related data sources: Haver Analytics, Bloomberg, bulwiengesa AG (for Germany’s main cities), National Statistical Offices, OECD and Eurostat regional statistics databases, and IMF staff calculations. - Data span: 2002–2014 (mostly due to constraints on city-level data availability). - Out-of-sample predictions: 2015–17 for German cities where data are more readily available. - City samples: - Ten German cities: Berlin, Cologne, Dortmund, Dresden, Dusseldorf, Frankfurt, Hamburg, Hannover, Munich and Stuttgart. - 12 large European cities: Amsterdam, Brussels, Copenhagen, Dublin, Helsinki, London, Madrid, Oslo, Paris, Rome, Stockholm and Vienna. ### Key estimation results and findings - Model results suggest house prices appear overvalued in some German cities. - In 2017: - Munich: house prices at 46 percent above the level suggested by fundamentals. - Hannover, Frankfurt and Hamburg: house price overvaluation gaps between 25 and 30 percent. - Stuttgart and Dusseldorf: signs of overvaluation between 10 and 15 percent, with gaps appearing to have stalled in 2017. - A population-weighted average of the overvaluation gaps in the 7 biggest cities (Berlin, Hamburg, Munich, Cologne, Frankfurt, Stuttgart and Dusseldorf) shows house prices 21 percent above fundamental level. - This 21 percent average is consistent with the Bundesbank’s assessment of an overvaluation gap between 15 and 35 percent. ### Regression results (Table 1 highlights) - Dependent variable: 100*log (real house price index, 2010=100). Results from a random effect model; numbers in parentheses are robust standard errors. Asterisks indicate significance: * p<10%. ** p<5%. *** p< 1%. - Selected coefficient estimates (Model (1) baseline; Models (2)-(4) add policy/institutional indicators): - Real GDP per capita, (index, 2010 =100): 0.696*** (Model 1); 0.702*** (Model 2); 0.711*** (Model 3); 0.709*** (Model 4). Standard errors: (0.184), (0.186), (0.186), (0.186). - Mortgage rate (percent): -3.903***; -4.087***; -4.090***; -4.082***. Standard errors: (1.436), (1.409), (1.368), (1.349). - fixed-rate dummy*Mortgage rate: 2.941*; 3.318**; 3.322**; 3.332***. Standard errors: (1.568), (1.525), (1.504), (1.469). - Population density (pers. per sqkm): 0.001* across models. Standard errors: (0.001). - Growth of employment rate, (percent): 0.788*; 0.818*; 0.806*; 0.808*. Standard errors: (0.427), (0.439), (0.431), (0.437). - Real estate investment (-2), (percent of GDP): 1.316; 1.258; 1.593; 1.534. Standard errors: (1.194), (1.180), (1.623), (1.628). - Construction price (-2), (index, 2010 =100): 0.110***; 0.114***; 0.111***; 0.111***. Standard errors: (0.039), (0.038), (0.043), (0.042). - tax relief*Real GDP per capita: 0.037; 0.041; 0.038. Standard errors: (0.043), (0.045), (0.044). - Rent control: -0.153; -0.141. Standard errors: (0.454), (0.457). - Supply responsiveness: 0.725 (standard error (10.679)) in one specification. - Constant: 374.772***; 372.041***; 371.170***; 389.578***. Standard errors: (20.869), (21.981), (22.016), (25.356). - Model fit and test statistics: - Observations: 256 (all models). - R-Square Overall: 0.306 (Model 1); 0.313 (Model 2); 0.318 (Model 3); 0.316 (Model 4). - R-Square Between: 0.219; 0.159; 0.148; 0.157. - R-Square Within: 0.259; 0.252; 0.247; 0.250. - Wald Chi-Square: 64.87***; 65.34***; 66.12***; 77.50***. ### Robustness and sensitivity - Results are robust to alternative specifications and additional control variables. - Institutional and policy variables (rent controls, tax relief for housing purchase, supply responsiveness) play only a marginal role at the city level. - Replacing the real mortgage rate by a number of potential equilibrium mortgage rates since 2010 yields: - Munich overvaluation gap range between 45 and 50 percent in 2017. - Hamburg, Frankfurt and Hannover overvaluation gap ranges between 25 and 35 percent in 2017. - The valuation gap exercise is based on specification (1) without insignificant variables. The red dots in Figure 3 present results based on the full model (including variables that are not significant). - Results robust to using 1 and 3 lags instead of 2 for the investment proxy. ### Implications - City-level analysis uncovers significant heterogeneity across German cities that country-level studies may mask. - Multiple major German cities, notably Munich, Hamburg, Frankfurt and Hannover, exhibited large housing valuation gaps in 2017, suggesting that a substantial part of recent price surges in these cities was not driven by the fundamentals included in the model. - Population-weighted city-level overvaluation is aligned with Bundesbank assessments, indicating consistency across independent analyses. *Source: IMF staff estimates and analysis from "STAFF REPORT FOR THE 2018 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX," Germany chapter (content unit: 6).* ### 2014. The 2006 ROSC Data Module mission found that the macroeconomic statistics generally follow ### cr18208 - 2014. The 2006 ROSC Data Module mission found that the macroeconomic statistics generally follow ### National Accounts and Real Sector - The 2006 ROSC Data Module mission found that the macroeconomic statistics generally follow internationally accepted standards and guidelines on concepts and definitions, scope, classification and sectorization, and basis for recording. - Areas for improvement: - Sources for estimating value added for a few categories of service industries could be improved. - A direct source for quarterly changes in inventories is lacking; extrapolations of changes in inventories are based on the difference between the monthly production index and turnover index in manufacturing. - Germany publishes—through Eurostat—general government revenue, expenditure, and balances on a noncash/accrual basis on a quarterly basis (ESA2010) and these data are presented in a GFSM 2014 format in International Financial Statistics, albeit with delay. - Germany submits annual data for publication in the Government Financial Statistics Yearbook, in GFSM 2014 format. Monthly data are disseminated on a cash-basis. ### Government Finance Statistics (GFS) - Comprehensive data reporting systems support the accuracy and reliability of the government finance statistics. - Data are based on cash accounting systems, although documentation exists to explain differences between the general government data in the ESA2010 (noncash) classification and general cash data on an administrative basis. - Monthly dissemination is on a cash-basis; quarterly noncash/accrual (ESA2010) data are available via Eurostat and presented in GFSM 2014 format in IFS with some delay. ### Monetary and Financial Statistics - The ECB reporting framework is used for monetary statistics and data are reported to the IMF through a “gateway” arrangement with the ECB, providing efficient transmission to the IMF and publication in the IFS. - Monetary statistics for Germany published in the IFS cover data on central bank and other depository corporations (ODCs) using Euro Area wide residency criterion. - Data based on national residency criterion is also published as memorandum items. ### Financial Sector Surveillance and FSIs - Germany participates in the IMF’s Coordinated Direct Investment Survey (CDIS), Coordinated Portfolio Investment Survey (CPIS) and financial soundness indicators (FSIs) databases. - Of the 40 FSIs, Germany reports all except net foreign exchange exposure to equity (I31). - Germany reports all of the 12 core FSIs; six FSIs are reported on an annual basis only: - NPL Net of Provisions to Capital - NPL to Total Gross Loans - Return on Assets - Return on Equity - Interest Margin to Gross Income - Non-Interest Expense to Gross Income - Plans are underway to change the legal basis for the periodicity of deposit taking institutions’ reporting requirements. - The quality of data on bank exposures submitted to the BIS needs improvement, including provision of the data on ultimate risk basis for advanced countries. ### External Sector Statistics - The Bundesbank compiles the balance of payments in close cooperation with the Federal Statistical Office. - Balance of payments, International Investment Position statistics, and related cross-border statistics are compiled according to the sixth edition of the Balance of Payments and International Investment Position Manual (BPM6), and the legal requirements of the ECB and Eurostat. ### Data Standards, Dissemination, and Metadata - Adherent to the Special Data Dissemination Standards Plus (SDDS Plus) since February 2015. - Currently disseminates a residential property price index and a commercial property price index. - Data ROSC from 2006 is available. - Table of Common Indicators Required for Surveillance (As of May 31, 2018) — selected dataset metadata and periodicity (dates and frequencies preserved as reported): - Exchange Rates — Date of latest observation: May 31, 2018; Date received: May 31, 2018; Frequency of Data: D; Frequency of Reporting: D; Frequency of Publication: D. - International Reserve Assets and Reserve Liabilities of the Monetary Authorities — Date of latest observation: April 18; Date received: May 18; Frequency: M; Reporting: M; Publication: M. - Reserve/Base Money — April 18; May 18; M; M; M. - Broad Money — April 18; May18; M; M; M. - Central Bank Balance Sheet — April 18; May 18; M; M; M. - Consolidated Balance Sheet of the Banking System — April 18; May 18; M; M; M. - Interest Rates — April 18; May 18; M; M; M. - Consumer Price Index — April 18; May 18; M; M; M. - Revenue, Expenditure, Balance and Composition of Financing — General Government — Q1:18; May 18; Q; Q; Q. - Stocks of General Government and Government-Guaranteed Debt — December 17; April 18; A; A; A. - External Current Account Balance — March 18; May 18; M; M; M. - Exports and Imports of Goods and Services — March 18; May 18; M; M; M. - GDP/GNP — Q1:18; May 18; Q; Q; Q. - Gross External Debt — Q4:17; March 18; Q; Q; Q. - International Investment Position — Q4:17; March 18; Q; Q; Q. - Footnotes and assessment keys preserved exactly as provided regarding methodological soundness and accuracy and reliability (O, LO, LNO, NO, NA) and frequency codes (D, W, M, Q, A, I, NA). ### Authorities' Statement and Policy Positions (Statement by Mr. Merk, Alternate Executive Director on Germany — June 29, 2018) - Macroeconomic performance: - The German economy has been performing well and its performance continues to be strong, sustainable, balanced, job-rich and inclusive. - Driven by domestic demand the upswing is ongoing; supply-side bottlenecks are reflected in strong wage growth and in higher domestic inflation. - Employment is continuing to increase and unemployment is expected to fall to a new record low in 2019. - Public government debt is decreasing towards the debt ceiling of 60 percent of GDP. - Risks and medium-term challenges: - Potential growth is set to slow down over the medium term. - Main risks stem from external factors and Germany’s demographic profile; aging is a major obstacle for stronger potential growth. - Mitigating factors include further increases in labor participation (especially of women and the elderly), a reduction in long-term unemployment, and qualified immigration. - Fiscal policy stance and views: - Fiscal Policies remain forward looking, prudent, and growth friendly; the fiscal stance in Germany is mildly expansionary, in spite of an increasingly positive output gap. - Public investment in physical and human capital will be increased further; authorities committed to tackle capacity constraints for public investment at the municipal level and to simplify tax administration. - The phasing out of the solidarity surcharge will reduce the labor tax wedge. - Authorities disagree with the assessment that there remains ample fiscal space after current government plans; they favor building buffers in light of demographic challenges and preparing for normalization of interest rates. - They emphasize a balanced federal budget as an anchor of stability. - Current account and external position: - Authorities reiterate that the German current account surplus results from private sector decisions and demographic factors; they expect the surplus to decline in the years to come as baby boomers retire. - They caution about model and estimation uncertainty in staff EBA “norms” and REER estimates; Bundesbank does not consider the REER significantly undervalued and assesses German price competitiveness to be neutral within reasonable error bounds. - They stress using the euro area balance as the primary reference for assessing current account developments. - Structural and investment policies: - Agree that higher domestic investment is desirable and list measures in the coalition agreement: increased supply of all-day childcare and all-day schools; expansion of training for refugees; investments in the expansion of high speed internet and 5G network. - New government initiatives to strengthen potential growth and incentivize private investment: - Support digital transformation through investments in digital infrastructure and improving supply of skilled labor; aim to roll out comprehensive gigabit networks; additional public investment predominantly aimed at rural areas. - Continue the transition to renewable energy sources while reducing uncertainty in the energy sector for private investors. - Strengthen labor supply, make it more attractive to extend labor market participation, support vocational training and life-long-learning, invest in integration of refugees, promote reconciliation of work and family life, and safeguard fairness of labor markets. - Support R&D to small and medium sized enterprises and improve framework conditions for venture capital. - Favor greater competition in product markets but express reservations about staff recommendations regarding reforms in professional services due to quality and consumer protection concerns. - Housing market and financial sector assessment: - Housing sector has seen rising prices, particularly in major German cities; authorities are monitoring closely and do not see immediate risks to financial stability. - Lack of substantial credit growth, no deterioration of credit standards, and households’ strong balance-sheets are cited as reassuring. - Authorities do not consider activation of borrower-based macroprudential tools to be warranted at present. - Financial sector is described as resilient with comfortable capital buffers in the banking and life insurance sectors; restructuring ongoing albeit slowly; low interest rate environment and strong competition remain challenging. *International Monetary Fund — Germany: Selected content from the IMF staff report and authorities' statement (as provided).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18208.pdf_