IMF Raises Prognosis for German Economy

Germany's stock market has been booming for more than three years. The country's companies have been enjoying better than average profits during that time. Now, it is starting to pay dividends and the International Monetary Fund, in its twice-yearly assessment of the global economy, has raised its 2006 economic growth forecasts for Germany to 2 percent from its prediction of 1.3 percent in the spring.

At its meeting in Singapore, the IMF's chief economist Raghuram Rajan praised Europe's largest economy, saying "it was on a roll."

But Berlin's measures to lower spending, such as merging unemployment and welfare benefits were not having as much as an effect that had been expected, Rajan said. He suggested lowering income taxes to help spur private consumption, recommending more flexibility in the labor market and increased competition in the banking and utilities sectors.

Adding more kick to the economy, Rajan said, alluding to reforms, would not necessarily mean lower incomes or the end of Germany's welfare state.

Europe should take advantage of growth

The IMF is not alone in its optimism regards Germany. The EU Commission projects growth of 2.2 percent. Only Berlin, possibly stung by overly rosy forecasts that went unmet in the recent past, sees more modest growth at 1.6 percent for the current year.

A scheduled increase of Germany's value-added tax (VAT) as of January will boost private spending until the end of this year. After that, the IMF expects growth to stagnate to 1.3 percent.

The economy in the euro zone is experiencing growth not seen since the dot.com days, expected to hit 2.4 percent. Rajan views the stronger developments as an opportunity to pare down public deficits, in line with the EU's Stability and Growth Pact target to hold such shortfalls to 3.0 percent or less of total output. As for Germany, he echoed his calls for reforms to Europe.

"Europe's leaders need to find the will to take on vested interests in both labor and in the corporate sector," said Rajan. "This necessary but difficult domestic battle is constantly postponed until after the next election," he added.

Balancing inflation and interest rates

Rising oil prices have yet had a great effect on consumer prices but with a barrel of crude expected to hover around or above the $70 per barrel mark, inflation is a concern central banks around the world must face.

The IMF found that with euro zone inflation running "below but close to" the European Central Bank's (ECB) 2.0 percent objective, "further interest rate increases will likely be needed to maintain price stability over the medium term if the expansion develops as expected."

The ECB since December has raised its benchmark rate four times, taking it from 2.0 to 3.0 percent, and has made clear it intends to carry on with monetary tightening. But the IMF cautioned:

"With underlying inflationary pressures still well contained ... policymakers can afford to be cautious in tightening the monetary policy stance, all the more so given the risk of euro appreciation and weaker growth in the United States."