Merkel hints at tax cuts for growth boost

Angela Merkel, Germany’s chancellor, has held out the prospect of government action, including possible tax cuts, to stimulate domestic demand in the eurozone’s biggest economy.

Ms Merkel said she was determined to revive Germany’s flagging growth, not least because of the country’s role “to do something for the stimulation of the economy in Europe”.

Speaking in Berlin after a meeting with Viktor Orbán, the Hungarian prime minister, she said the government had selective tax cuts in mind as one means to boost growth. If Germany could deliver higher domestic consumption, “that would have the advantage that we would naturally be able to buy imports from other countries in the European Union”.

The government is expecting a growth rate in the current year of just one per cent – compared with 3 per cent in 2011.

But Germany was also affected by “the collapsing economies in some eurozone countries”, she said. If there were also a slowdown in the Asian economies, Germany would naturally not be decoupled.

Ms Merkel’s hint of tax cuts came as the country’s top economic institutes said Germany faces a “great danger” of falling into recession if the eurozone crisis deteriorates.

Germany faces a “great danger” of falling into recession if the eurozone crisis deteriorates any further, the country’s top economic institutes said on Thursday.

The twice-yearly forecast by four institutes, whose analysis influences government forecasting, split experts down the middle on whether the European Central Bank’s new policy of offering to buy sovereign bonds represents a grave inflationary threat or could be viewed as a suitable step to calm debt markets.

While the institutes’ overall forecast was for Europe’s largest economy to grow 0.8 per cent this year and 1 per cent next, they said this was based on a gradual stabilisation of the eurozone crisis and the restoration of investor confidence.

“[But] the downside risks prevail and there is a great danger that Germany will fall into a recession,” they said in a report.

On the subject of the ECB’s so-called outright monetary transactions, or OMT programme, the institutes said it “could shake the main pillar of the currency union, namely price stability”, and attacked the central bank for “blurring responsibility for individual policy areas” and sacrificing its independence from fiscal policy.

However, the Kiel Institute for the World Economy and Essen-based RWI both said bond-buying was “fundamentally suited” to stabilising distressed markets or dealing with fears of contagion. But, they added, “it is not a good solution for the central bank to take on this task”.

The two other institutes, the Munich-based Ifo and the Halle Institute for Economic Research, took a much harder line, saying that all bond-buying schemes represented too great a risk of unleashing inflation, a fear that features prominently in both popular and academic debate in Germany.

Criticism of the OMT programme outlined by Mario Draghi, ECB president, as part of a pledge to do “whatever it takes” to save the euro is widespread in Germany due the theoretical risk that the policy may fuel inflation. Although Angela Merkel, chancellor, has tacitly backed the plan, Jens Weidmann, head of the Bundesbank, was the sole member of the ECB’s 22-strong governing council to vote against it in September and has said it is “tantamount to financing governments by printing banknotes”.

The ECB has yet to make any OMT bond purchases as no country has applied to Europe’s bailout fund for help, which is a necessary first step.

The economic institutes forecast no immediate threat of rampant inflation and predicted a stable unemployment rate of 6.8 per cent in Germany for both 2012 and 2013. However, they said the ECB’s loose monetary policy created midterm risks of fuelling a bubble in the German property sector, although “debt-financed excesses” seen elsewhere in Europe “seem unlikely at the moment in Germany”.

All four institutes backed austerity twinned with reforms aimed at promoting growth as the “best way” of restoring confidence of public finances in crisis countries, but they added, “there has been growing doubt as to whether this strategy alone will produce the desired result”. The economists noted this left only three politically unacceptable options: north-south transfers to cut public debts; a state declaring insolvency; or devaluing public debts through inflation.

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