Berlin Concerns about stagflation, i.e. high inflation combined with weak growth, are making the rounds in Germany. Companies have great problems getting up-front services as global supply chains are broken and this leads to massive bottlenecks. Some companies are already having to cut their production and send employees on short-time work.
Added to this is a sharp rise in the price of raw materials, especially energy, which drove inflation in Germany to a rate of over four percent in September compared to the previous year. The interrupted supply chains are arguably the greatest risk to the economic recovery. On the other hand, it is not higher inflation, it is welcome and necessary for the transformation of the German economy.
In addition to stagflation, the discussion about what is known as “green inflation” is gaining in importance. Above all, the prices for energy are skyrocketing, in some cases they have risen by 50 percent or more. Quite a few in Germany knit the narrative that climate protection is responsible for rising energy prices. The critics argue that it not only fuels inflation, but above all harms the poorest people, because they spend a particularly large part of their monthly income on energy.
The introduction of the CO2 price and stricter regulation not only increased inflation, but also harmed companies that lost their competitiveness, so that good jobs in Germany were lost. This narrative of expensive climate protection catches on with some groups in Germany.
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But it is not climate protection and the CO2 price that lead to problems in supply chains and to increased inflation, on the contrary: Climate change itself and the global trade conflicts it has triggered pose the greatest threat.
Corona causes raw material prices to explode
Probably the most important reason for the skyrocketing raw material prices is the corona pandemic, which repeatedly requires economic restrictions to stop the virus. The partial closure of a large Chinese port in the summer of 2021 triggered shock waves in the German economy, because many companies, especially in the automotive industry, are now so closely interlinked with the Chinese economy that even such a comparatively small disruption causes enormous distortions in this country .
Even if only a small part of the preliminary work is missing, this can bring an entire production process geared to just-in-time deliveries to a standstill or even to a standstill. A second reason is the sometimes significantly higher demand for raw materials, as the global economy is recovering faster than expected.
Some cite “green inflation” as the third reason for rising energy and raw material prices. But the narrative that “green inflation” is harmful and bad is cynical and wrong. On the one hand, almost everyone wants more climate protection. On the other hand, there are now complaints about increased energy prices and inflation because CO2 is taxed. This is exactly the economic mechanism of climate protection: prices should better reflect the harmful behavior of companies and people – for example the consumption of fossil energy sources – in the future.
In other words, a certain amount of “green inflation” is right and necessary. It reflects an adjustment of relative prices – the prices for climate-damaging behavior must rise in order to set incentives for innovations and alternative, ultimately climate-neutral economic processes. In addition: Is a price increase caused by a higher CO2 price really that bad and harmful?
In the D-Mark era, the inflation rate was 3.1 percent
If the calculations, according to which CO2 pricing will be accompanied by an inflation rate higher by 0.5 percentage points in the next few years, are correct, inflation in Germany would no longer be an average of 1.4 percent, as in the past 20 years, but rather 1.9 percent. That would be just as unproblematic for Germany as an ECB inflation target of 2.5 instead of 2.0 percent.
For comparison: In the D-Mark era, the inflation rate averaged 3.1 percent from 1957 to 1998. Nobody in Germany today complains about inflation being too high in these decades, but many look back – some with nostalgia – on these years as an economically excellent time with a strong D-Mark and stable prices.
The mistakes in the discussion about “green inflation” lie elsewhere: First, the more important reason for the rise in raw material prices is not climate protection, but climate change. For example, wood has become more expensive because the supply is scarce due to the increasing frequency of forest fires and pest infestation – both consequences of the increasing drought.
Another example is the drought in China last year and this year, which led to water scarcity and reduced the water level in many dams so much that energy generation from hydropower fell significantly. Numerous factories in southern China had to stop their production two or even three days a week in the summer of 2021. This also leads to delivery bottlenecks and shortages, which ultimately increase prices.
Climate change costs more than climate protection
The flood disaster in West Germany in July 2021 also shows how great the direct, also economic damage of climate change is in this country. Shortages, price explosions and disruptions in supply chains usually arise when unforeseen problems such as natural disasters occur. These are never the result of climate protection measures or CO2 prices. They are the inevitable result of climate change.
In short, climate protection is not the cause of inflation and a problem for the economy, but climate change. In addition, climate protection will lower energy prices in the long term. Renewable energies are more efficient and therefore cheaper than fossil fuels. Regulation and CO2 prices may contribute to higher energy costs in the short and medium term. In the long term, however, they reduce this and lead to lower inflation.
The problems with the supply chains are the greatest risk to the economic recovery for the next year and the year after that. It may well be that the forecast economic growth figures in Germany of 4.5 percent or more in 2022 are unrealistic because there will be problems with the supply chains again and again.
The worst thing is to complain about climate protection and CO2 prices, because both are essential to secure supply chains and basic supplies. The best that politicians in Germany can do is to continue their expansive financial policy and to provide corona-related help for companies, including short-time work benefits, in the coming year.
The author: Marcel Fratzscher is President of the German Institute for Economic Research (DIW) in Berlin and Professor of Macroeconomics at Humboldt University.
More: IMF expects significantly higher inflation.