The German economy is presently booming, but political uncertainty is introducing new risks to this trajectory. Following the German general election on September 24, Chancellor Merkel and her Christian Democratic Union (CDU) entered into negotiations with the Free Democrats (FDP) and the Green Party on forming the next government. The collapse of the coalition negotiations on November 19 is not a huge surprise given the ideological differences among the center-right CDU, the economically liberal FDP and the environmentally-conscious Greens. Not only could political uncertainty have a knock on-effect on the German economy, but it also makes it harder to pursue further integration in Europe.

So what happens now? There appears to be three options. First, the CDU has been governing Germany in coalition with the center-left Social Democrats (SPD) since the last general election in 2013. In theory, the CDU could form a new "grand coalition" with the SPD, but the latter has ruled out that option. Second, the CDU could govern as a minority government. Because the CDU does not have a majority of seats in the Bundestag, the lower house of the German parliament, it would need to pass legislation with other parties on an ad hoc basis. However, minority governments tend to be unstable because they can easily be brought down by no confidence motions. Third, the federal president could call for a new election. However, President Steinmeier seems reluctant to call new elections, at least at this point, because of the risk that fringe parties could garner even more votes than they did in September. In short, Germany seems set for a period of political uncertainty.

If voters cared only about pocketbook issues the CDU would have been returned overwhelmingly to power in the September elections, because the German economy is booming at present. Real GDP was up 2.8 percent in Q3-2017, the strongest year-over-year rate of growth in six years (Figure 1). Moreover, growth is broad-based at present with consumer spending, investment spending and exports all contributing positively to the overall rate of real GDP growth. Growth in real retail sales has strengthened markedly this year (Figure 2), and unemployment has declined to the lowest rate in the post-reunification era (Figure 3). The Ifo index of German business sentiment stood at an all-time high in October (Figure 4), suggesting that growth has remained buoyant thus far in the fourth quarter.

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But pocketbook issues are not the only considerations that motivate citizens to vote for individual candidates or political parties, and Germany has not been immune to the populist/nativist voices that have affected elections in other western countries in recent years. Political uncertainty could have a marginal negative effect on the German economy in the near term, although it is not likely to derail the expansion that is underway in Germany. However, Chancellor Merkel was weakened by the election results, and she will be weakened further if she needs to govern via a minority government. There could also be implications for Europe from the inability to form a coalition. A weakened Merkel will find it harder to persuade other German politicians to agree to the deeper European integration proposals that French President Macron has proposed.

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