German economy: growth forecast 2009

According to the FTD, the head of the German Institute for Economic Research (DIW) in Berlin, Klaus Zimmermann, calls for a stop of growth forecasting by economists. The results would be “confusing”. Stopping growth forecasting would be a sign of “intellectual Redlichkeit” (honesty). He admits that in most economic models financial crisis are not included, so nothing could be said about how bad it will be:

“In den meisten Modellen, die wir für unsere Vorhersagen nutzen, kommen keine Finanzkrisen vor. Und wenn sie vorkommen, dann ist diese Krise so spezifisch, dass wir sie nicht erfassen können. Wir können sagen, da passiert was Schlimmes, aber wie schlimm es wird, können wir nicht sagen.”

If economists at the DIW have nothing to say about financial crisis, they use the wrong models. There are many which include financial crises (look here, or here, or here, or, here), and if they don’t use them it just means they apparently have misunderstood something about how the economy works (look here). Of course, the models cannot give precise answers as can the dynamic stochastic general equilibrium models (which have failed), but to quote Keynes, it is better to be roughly right than precisely wrong.

Now, my forecast is of the quick and dirty kind and is not based on a complex model but on theoretical thinking about the economy. There are two scenarios:

1) 2009 without fiscal stimulus: if economists cannot persuade the politicians by argument that fiscal policy, coordinated on a European level, is necessary to increase demand and improve the forecast of entrepreneurs, than we will have a shrinking economy. Demand will fall, hence investment falls, and this will cause a rise in unemployment. If deflation arises, it will be very bad. But:

2) 2009 with fiscal stimulus: If economists manage to finally persuade German politicians to come up with a significant fiscal stimulus, than the situation can be softened and growth might hoover at around zero. Demand is propped up by fiscal policy, there is no threat of deflation.

It is important to see which scenario plays out. Until now, economists in Germany seem to have no influence on politicians anymore (at least not those in control, like Mrs Merkel). The cause might be the council of economic advisers (Sachverständigenrat), which strongly warned against fiscal policy in March 2008 and now calls for it. That must be confusing for politicians. The other explanation is that economists do still have influence, but suggest the wrong policies. That would be a shame. All along, economists have assured the public that the lessons of the Great Depression have been learned.

UPDATE 09/01/2009: As reported, on December 16th the head of the DIW called for a stop of growth forecasting. Well, this apparently does not stop him from making his own opinion known in the press. In the Tagesspiegel, he said:

Es wird insgesamt schon ein Minus geben. Aber es wird nicht so dramatisch, wie viele befürchten. Wir gehen davon aus, dass es ebenso steil bergab wie ab Mitte 2009 wieder bergauf gehen wird und die Wirtschaft dann wieder wächst. Allerdings werden viele Länder in der Krise stecken, die für den deutschen Export wichtig sind: die USA, Großbritannien, Japan, Spanien. Glimpflich davonkommen werden Osteuropa, Indien oder China. Erst 2010 wird sich die Besserung festigen.

Well, to summarize this quickly: the recession will not be dramatic, the summer 2009 will bring the turnaround and growth will return. Hardest hit will be the US, the UK, Japan and Spain, the least problem will have Eastern Europe, India or China. 2010 will see the return to constant growth. In the interview it also becomes clear that Zimmermann is an Austrian:

Ein Abschwung wirkt in gewisser Weise reinigend, nur gesunde Unternehmen überleben. Er beschleunigt überfällige Reformen, etwa den Umbau der Landesbanken. Und er drängt Branchen dazu, sich neu aufzustellen – etwa die Autoindustrie, die dringend mehr energiesparende Technik anbieten muss.

So only the strongest firms survive, the recession heals the economy, and so on and so on. This is what the Austrian school of economics preaches. However, they are not able to explain the resulting unemployment. If you are interested in why, I recommend Paul Krugman’s critique The Hangover Theory.