| Summary: | This Selected Issues paper highlights impact of high-energy prices on Germany’s potential output. The surge in energy prices since Russia’s invasion of Ukraine has led to a contraction in the energy-intensive sector’s production, while the nonenergy intensive sector’s industrial production has remained resilient. Permanently higher energy prices could reduce Germany’s potential output, but some of the impact is expected to be offset by firms’ endogenous response to improving energy efficiency. Some decline in Germany’s potential output level because of higher energy prices is likely unavoidable. However, good policies can help mitigate this loss and avoid exacerbating it. Increased energy efficiency is key to mitigating the adverse effects of the energy price shock. Higher labor and capital productivity can help offset output losses from higher energy prices. Government policy can help boost productivity by fostering innovation and human capital development, as discussed in more detail in the 2023 and previous year’s Article IV reports. Government interventions can help direct the transition to cleaner energy. It is important that Germany respond to the energy shock in ways that also support the green transition, given Germany’s goals to significantly reduce its CO2 emissions
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