The term stagflation is reminiscent of the ghost of the 1970s, which had long been believed to have been displaced, when, as a result of oil price shocks, inflation rates soared in the industrialized countries and at the same time economic growth was stifled.
In Germany, the then Federal Chancellor Helmut Schmidt tried to counter this supply shock with economic stimulus programs that aimed to replace the lack of private demand with additional, credit-financed state demand – in vain! The unions, which were still strong at the time, were able to push through strong wage increases in the expectation of further rising prices, which further fueled inflation and set a wage-price spiral in motion.
The Bundesbank’s only chance was to break inflation expectations through a credible, restrictive monetary policy based on established rules – even at the cost of a recession.
Today, almost 50 years later, it is therefore not surprising that the ECB leadership never tires of emphasizing that the marked price increases in large parts of the euro zone are of a temporary nature and do not require a correction of their expansionary monetary policy. “Some influencing factors are likely to disappear again soon, such as the price-driving effects that result from disrupted supply chains or from the withdrawal of the VAT reduction in Germany,” said President Christine Lagarde. “For this reason we shouldn’t overreact now.”
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Not only in inflation-phobic Germany, however, is the reading widespread that the ECB simply refuses to recognize reality. In September consumer prices in Germany rose by an impressive 4.1 percent. And the sharpest jump in wholesale prices since the 1974 oil crisis showed that the return to the previous VAT rate is at best a small part of this phenomenon. In addition, the price increase in the entire euro area of 3.4 percent confirms that the wave of inflation is by no means just a German problem.
Prof. Bert Rürup is President of the Handelsblatt Research Institute (HRI) and Chief Economist of the Handelsblatt. For many years he was a member and chairman of the Advisory Council as well as an advisor to several federal and foreign governments. You can find out more about the work of Professor Rürup and his team at research.handelsblatt.com.
Not likely to be a passing phenomenon
Furthermore, it is unlikely that this will remain a temporary phenomenon. In some EU countries, for example, public sector salaries are linked to inflation, and the first German trade unions have already called for substantial wage increases, referring to the rise in prices. The construction industry is even threatened with the biggest strike in two decades, with which IG Bauen-Agrar-Umwelt wants to emphasize its demand for 5.3 percent more wages.
With the labor market emptied in many industries, there is little doubt that the unions will get the “big swig from the bottle”.
In addition, there is the decision to increase the minimum hourly wage in two stages to 10.45 euros for 2022. In addition, the new federal government is likely to hold out the prospect of further rapid increases in this lower wage limit towards twelve euros. In order to maintain the wage structure, noticeable wage increases in the other wage groups should not be long in coming.
Another factor driving inflation is the fact that many rental contracts provide for “inflation indexation”. Many existing tenants will therefore soon have to expect noticeable rent increases. In addition, it is politically desirable that many products become noticeably more expensive in the fight against climate change. At the beginning of the year, the federal government introduced a new CO2 tax, the amount of which will gradually increase in the coming years.
The aim is to make the consumption of fossil fuels more expensive and thus to limit it. The levy not only makes direct energy consumption more expensive. As a result of rising production and transport costs, almost all everyday goods are likely to become more expensive.
Hope for a boost in innovation
Now there may be hope that courageous progress by Germany in terms of climate protection might not save the world climate, but it could trigger a surge in innovation and thus a surge in growth. While this is possible, it is by no means certain. After all, history is full of examples of political misjudgments that had fatal consequences for the economy and society. So there is no guarantee that decarbonization will become a growth driver.
While this experiment is running with an uncertain outcome, Germany will be confronted with a massive surge of aging from the middle of the decade, which is a massive brake on growth. While the production potential of the German economy rose by almost 1.5 percent annually in the past decade, the Council of Economic Experts now assumes that this trend growth will have fallen to around one percent by the middle of this decade.
Employment will probably peak in two years’ time. And from 2026 around 130,000 people will retire of working age every year, estimates the Institute for the World Economy. In perspective, there is a threat of age-related stagnation – with noticeably rising prices. The specter of stagflation returns.
Sure, the ECB is powerless against inflationary impulses that spill over into Europe through imports from the Far East. Wages in China, Germany’s most important supplier for years, have risen sharply, so that further price reductions, for example for everyday electronics, are not to be expected. And the ECB cannot do anything about Asia’s hunger for raw materials, which is driving up prices, as well as against permanent price increases for semiconductors as a result of the current chip crisis.
The ECB should actually take countermeasures – but that is not to be expected
But actually the ECB should pay close attention to self-reinforcing second-round effects and counteract any looming wage-price spirals in good time. However, this is not to be expected. The fear of the ECB leaders about new financing problems of some southern European euro states and about turbulence on the financial markets seems to be too great.
In addition, the ECB has committed itself to a “greener” monetary policy, which makes it difficult for it to combat inflation due to climate protection. Furthermore, the ECB can do little to prevent wages in Germany and other strongly aging economies from rising permanently, not as a result of short-term overutilized capacities, but rather because of a chronic shortage of skilled workers. In short, the ECB will do little to counter even permanently higher inflation rates.
The monetary politicians in Frankfurt are of course also aware of all this. With their new inflation target, which has apparently only been cosmetically raised, however, they have created the opportunity to tolerate higher rates of inflation over a longer period of time while saving their faces. Because the new inflation target of two percent is symmetrical: If the ECB missed its self-imposed inflation target year after year between 2013 and 2020, it could now, in mirror image, tolerate corresponding upward deviations in the current decade.
The era of very low inflation rates is therefore likely to be drawing to a close. It is possible that future economic historians will describe the corona outbreak as the end of abstinence from inflation.
The prospects for the next federal government are not rosy
The prospects for the next federal governments are not rosy. On the one hand, inflation consistently hits the economically weak more severely than the stronger, which requires additional social compensation. At the same time, the foreseeable weaker growth means that fewer funds can be distributed.
On the other hand, it is important to make aging Germany more attractive for international investors through better supply conditions, i.e. more favorable depreciation rules and moderately reduced corporate taxes, while at the same time the location must not be made unattractive by one-sided environmental requirements.
Finding the right balance will not be an easy task. The future government cannot afford to make many unsuccessful attempts.
More: IMF chief economist: “Germany faces major challenges”