Germany should loosen its purse strings, cut income tax and increase spending on infrastructure to avoid long-term low inflation, the International Monetary Fund said Monday.
The fund also called on Europe's economic power house to boost wages and help the European Central Bank to end its ultralow interest rate policy.
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"A sustained rise in wage and price inflation in Germany is needed to help lift inflation in the euro area and facilitate the normalization of monetary policy," the IMF said in the conclusions of its Article IV consultation with Germany.
The IMF said its baseline forecast envisaged a gradual demand-driven rise in wage, core and headline inflation, which is consistent with the country's tight labor market conditions. It also suggested a long period of moderation could result in low wages, leading to protracted low inflation in Germany and a slower-than-expected normalization of inflation and monetary conditions in the euro area as a whole.
It warned that in such a scenario, "The rebalancing of competitiveness in the euro area would be delayed."
The IMF also renewed its call for Chancellor Angela Merkel's government to do more to boost Germany's domestic demand amid a budget that has posted a surplus since 2014.
The finance ministry said Germany would continue with its solid fiscal policy, in comments that suggest the differences in opinion between Berlin and the fund persist.
"Structural reforms and budget consolidation are decisive prerequisites to stimulate growth and further improve the climate for private investment," the ministry said in a statement on the IMF's report.
Germany's economy, Europe's largest, is in a healthy state, with the government predicting growth of 1.4% this year. During the first quarter, the economy grew an annualized 2.4%, outpacing growth in the U.S., the U.K., Japan, France and Italy. Canada is the only Group of Seven country that could record a stronger first-quarter result; it publishes its estimate in late May.
Germany is also in a comfortable fiscal position to boost domestic demand.
Tax-revenue estimates released Thursday showed the strong economy and labor market would deliver a EUR54.1 billion ($59.12 billion) windfall through 2021, underlining the firepower at politicians' disposal.
Ms. Merkel and Finance Minister Wolfgang Schäuble have said they see leeway for EUR15 billion in annual tax cuts.
In its reaction to the IMF report, the finance ministry said Monday that Mr. Schäuble sees room to cut taxes for some people in the next legislative term, which beings after the Sept. 24 national election.
The IMF said high wages and price growth also would be needed to achieve external rebalancing of Germany's economy, given its current account surplus, which was the world's largest in U.S. dollars in 2016.
"The surplus is expected to narrow slowly over the medium term, as energy and other import prices recover, private investment strengthens, and wage growth supports both domestic demand and a realignment of external competitiveness," the IMF said.
"However, under current policies, the projected adjustment is limited...Policies that boost public and private investment and reduce the need for private saving (such as through promoting longer working lives) would accelerate the necessary external rebalancing process," it said.
The German finance ministry, however, gave no indication it would embrace any big policy change to trim the current account surplus
"The German government and the IMF share the view that commodity prices and exchange rates are factors affecting the current account balance that aren't within the sphere of influence of German politics," the ministry said.
In March, Germany posted the highest monthly current-account surplus since records began after the country's unification in 1991, coming in at EUR30.2 billion.
The record surplus has played into the hands of critics who say Germany's economy depended too heavily on exports to drive growth and was too reluctant to invest at home. Those critics include the U.S., particularly under President Donald Trump, which says the weak euro is inflating Germany's trade surplus.
In a visit to Washington last month, Mr. Schäuble said the euro was weak partly because of the ECB's stimulus programs, rather than because of any action of the German government. He also said it wasn't in anyone's interest to make a strong and competitive economy weaker by artificially hurting exports.
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(END) Dow Jones Newswires
May 15, 2017 12:26 ET (16:26 GMT)