LONG HAUL AHEAD FOR GERMANY / THE WALL STREET JOURNAL

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AUGUST 19, 2009, 12:28 P.M. ET

Long Haul Ahead for Germany

By MATTHEW CURTIN

Once bitten, twice shy. German policy makers are yet to celebrate at signs the euro zone's biggest economy is recovering faster than expected. Berlin is looking at ways to avoid a second-round credit squeeze next year. The Bundesbank warns Germany is five years away from regaining last year's level of economic output.

Such caution is understandable. The authorities were wrong-footed by the collapse in industrial output during the credit crisis, exposing German banks' high leverage and the country's overdependence on exports.

Long-term fixes are still not in place. Germany is yet to embrace a state-led recapitalization of its banks, such as those adopted by the U.S. and U.K. Efforts to rebalance the economy towards consumer spending remain modest. And successful stop-gap measures, notably a car-scrapping scheme and subsidized short-term work contracts, end this year.

BNP Paribas reckons the short-time work program has kept the jobless rate three percentage points below what it would have been. It was 8.2% in July. And despite all the European Central Bank's efforts to unblock credit markets, small and medium-sized German companies still complain about diminishing access to bank credit. They'll need more to rebuild inventory as demand recovers in the months ahead.

It all points to a lackluster outlook for domestic demand and investment considering few predict strong rebounds in countries like the U.S., U.K. and Spain, among Germany's most important export markets. Wednesday's producer-price inflation data, showing the severest decline in 60 years, is a reminder of massive excess capacity that a mild recovery won't absorb. Unless Berlin can stimulate domestic demand, a bout of deflation remains a danger.

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