(Originally published here.)
Why did the European Central Bankhold off on cutting interest rates today in the face of signs that the euro area is on the verge of deflation? One possibility: The German economy is doing much better than last year and may be 2.5 percent to 3.5 percent bigger than reported in the official statistics. (This would be in addition to the impact of the European Union’s planned changes in GDP accounting standards, which will take place this summer.)
The possibility was raised by Carsten-Patrick Meier at Kiel Economics Research & Forecasting GmbH & Co. and initially reported by Henrik Muller in Der Spiegel. The article was in German, which may explain why no one in the English-speaking press seems to have noticed it. I spoke with Meier earlier today and his case is compelling.
First, consider that Germany’s Federal Statistics Office revises its annual gross domestic product estimates with a long lag. The 2011 GDP estimate was revised higher this past August. The 2013 estimate won’t be revised until August 2015. Those revisions often reflect changing estimates of construction spending and services, which are hard to calculate in real time. As a result, the initial estimates tend to track data on foreign trade and manufacturing. This bias doesn’t usually create problems, but it would explain how the Statistics Office might miss an economic boom driven by domestic consumption.
Plenty of data support the theory that the German economy is stronger than meets the eye. The monthly Ifo Business Climate Index is near its highest level since reunification, suggesting growth of about 3 percent in 2013. The DIHK Business Survey shows a similar level of optimism. Consumer confidence data from Icon and the European Commission correspond to a growth rate of a little more than 2 percent. The GfK data on income expectations is at an all-time high. The ZEW survey of German growth expectations suggests GDP growth of about 3.5 percent last year and 4 percent for this coming year.
Even if you don’t buy the survey data, there are other indicators suggesting a hidden German boom. The Bundesbank measures wage contracts that have been negotiated for the coming year. These show that workers have already locked in hourly pay increases of more than 2 percent this year on top of raises of more than 2 percent in 2012 and 2013. In the years before the crisis, German workers received hourly pay increases of 1 percent or less. Germany is also adding jobs at a rapid rate even though the country’s population has been shrinking. Employers wouldn’t be doing this if the economy were barely growing.
The implication is that the German output gap is much smaller than believed, and proposed government spending measures might lead to several years of wage growth of as much as 5 percent. German inflation, which has been held back by quiescent commodity prices and depression in much of Europe, will also accelerate as consumers get more money in their pockets and feel more comfortable spending it. That would be good for ordinary Germans and also for their European neighbors, who would have an easier time improving their relative competitivenesswithout having to endure pay cuts.
(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)
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