German Economy Riding Five-Year High

The Organization for Economic Cooperation and Development (OECD) said on Tuesday that it expects the German economy will continue to expand in the coming two years. In its latest World Economic Outlook, the OECD predicted that growth in gross domestic product would reach 2.6 percent in 2006, 1.8 percent in 2007 and 2.1 percent in 2008.

"The economy has entered a period of sustainable recovery is projected to grow above potential throughout the projection period," according to the report.

Consumer polls support -- at least in part -- the optimistic forecasts. A survey published on Tuesday by the Association for Consumer Research in Nuremberg (GFK) revealed that Germans are more willing to spend money on durable goods now than at any point since 2001. The rise in domestic consumer spending has been a key factor in lifting Europe's biggest economy out of the doldrums.

That, in turn, has led a dramatic reduction of Germany's budget deficit. The OECD predicts that Berlin will only run a deficit of 2.3 percent of GDP for 2006 -- the first time since 2002 that Germany has managed to stay within the 3 percent upper limit on deficit spending laid down by EU Stability and Growth Pact.

But experts disagree as to whether the upswing represents a long-term trend or merely a temporary spike, as Germans make major purchases before a tax hike comes into effect.

VAT's up with the economy?

There's general consensus that Germans are spending more now because of the government's plan to raise the Value Added Tax (VAT), or sales tax, from 16 to 19 percent in 2007.

"The rational decision to bring forward purchases to miss the impending VAT increase in particular is likely to provide an additional boast in domestic demand at the end of the year," a survey published by the Association for Consumer Research in October already concluded.

According to that survey, almost a third of Germans were buying now so as to avoid paying 3 percent more next year.

That would suggest that consumer spending will substantially diminish in 2007, possibly putting a screeching halt to the economy's overall performance. The OECD, too, thinks that the rise in VAT will cost Germany around a quarter of a percentage point in GDP growth next year. For that reason, the organization's predictions for Germany in 2007 are less positive than for 2006 or 2008.

The OECD believes that the dip could well be offset by a drop in unemployment, which would bolster domestic spending. And the organization said that overall the risks to the economy were "well-balanced."

No guarantees

But there are other less promising scenarios.

"A stronger impact from the VAT increase cannot be excluded," the OECD wrote. "A significant appreciation of the euro could undermine recovery, as could a somewhat more protracted weakening of the US and the global economy."

The Association for Consumer Research said that while Germans feel good about spending money now, increasing numbers of them fear that their disposable income will decrease next year, perhaps leading them to become more frugal.

2007 may thus become a watershed year for the German economy -- and, with it, Chancellor Angela Merkel's grand coalition. If the recovery continues, Merkel's cabinet can take credit for bringing deficit spending under control. But if the economy returns to the doldrums, voters are likely blame those politicians who approved a potential risky tax hike.