Regardless of which political camp Germany’s citizens are close to – most of them share an almost pathological fear of inflation. One could get the impression that in the 1970s – a time when the inflation rate in Germany was briefly above seven percent – the Bundesbank’s inflation target of “two percent at the most” had become part of the national DNA.
While economists agree that inflation shouldn’t be too high or erratic, there is no such thing as an optimal rate of inflation. And if there were, it would certainly not be constant in the long term, but a variable that depends on changing circumstances. Nobody can say with certainty that one percent inflation would a priori be better or worse for society as a whole than three percent.
It is clear, however, that the open German hyperinflation of the early 1920s and the hyperinflation that was later backed up until the currency reform in 1948 were ugly economic problems that could only be overcome with currency reforms. No less ugly are the consequences of a deflationary depression, namely a persistently insufficient overall economic demand and a falling price level. This has happened once in modern world history: from the end of the 1920s to the mid-1930s – also, but not only, in Germany.
Against this background, the most important goal of monetary policy is to stifle such undesirable developments, which can hardly be controlled politically, right from the start.
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The two percent inflation ceiling set by the Bundesbank was declared an explicit goal of the European Central Bank (ECB) at the start of the European Monetary Union. This was a clear signal that European monetary policy was also aimed at price stability. The much higher inflation expectations in other euro countries were successfully suppressed.
Several price drivers in the coalition agreement
Inflation always has undesirable distributional effects – mostly at the expense of low-wage earners. However, at least part of the inflation rate in Germany today is politically conditioned and expressly wanted – beyond the temporary VAT caprioles in the fight against corona, the effects of which on the inflation rate will have been eliminated by the turn of the year. If you look at the coalition agreement, you can identify several permanent price drivers.
Energy from fossil fuels is to be gradually made more expensive by increasing taxes. Since energy has a share of around ten percent in the shopping basket relevant for measuring inflation, a ten percent increase in the price of energy leads, according to a rule of thumb, to one percent inflation. Duty-free energies from regenerative sources counteract this, but initially also require investments that drive prices upwards.
In order to promote the energy transition and to increase its acceptance, the last federal government granted numerous subsidies. And one can assume that the Ampel-Coalition will initiate further funding programs, for example for energy-efficient building renovation, e-mobility or for new heating systems.
But subsidies mean that part of the funding always ends up with the provider, as the provider can achieve a higher price for his product on the market than would be the case without the subsidy. There is much to suggest that, without subsidies, e-cars, heating systems, insulating materials and the associated craftsmen’s services should be a little cheaper than is currently the case. As a demand booster, the state is pushing the rate of inflation up a little.
Minimum wage increase with far-reaching consequences
Another so far neglected effect in the discussion about the longer-term development of inflation is that the new government is planning a rapid increase in the minimum wage from currently just under ten to twelve euros an hour – in terms of the matter, but not in accordance with the correct procedure. According to estimates by the unions, this should bring about eight million employees noticeable wage increases and higher labor costs for their employers. In fact, the consequences are more far-reaching.
Because all those who already earn collectively agreed upon twelve euros or just above, should also push for wage increases and use the argument to maintain the existing wage structure in a company or an industry. Given the labor shortage in large parts of the economy, including in the low-wage sector, there is little doubt that many workers will be granted these increases. The resulting increase in wage costs is likely to have an impact on consumer prices, as the companies weakened by the pandemic will have to pass these costs on.
Ultimately, these price increases are politically wanted – and the underlying argumentation is likely to be fundamentally supported by many citizens. However, this does not change the fact that politically desired inflation also lowers the real income of citizens – with all the well-known consequences of a loss of prosperity due to less consumption and thus also lower economic growth.
Even in the hypothetical case that there would still be an autonomous monetary policy for Germany, the question arose of what a monetary stability-minded central bank could do about this inflation – and above all, whether it should do something. Ultimately, by tightening monetary policy, it would undermine government policy, slow down decarbonization and weaken the urgently needed growth forces of the economy through higher interest rates.
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.
This raises the question of whether the Bundesbank’s old inflation target is still appropriate today in view of the decarbonization associated with a rise in costs for the economy as a whole. A tighter monetary policy could counteract an economically sensible climate policy that primarily relies on price signals. This would call into question the usefulness of an independent central bank.
In addition, the long-term price-dampening effect of globalization and, above all, the integration of China and other Asian countries into world trade is likely to flatten noticeably in the coming years. On the one hand, protectionist restrictions are increasing around the world. On the other hand, wages in China have risen significantly in recent years, so that, in conjunction with the rapid aging of the population there, it is uncertain whether everyday electronics will continue to get cheaper and cheaper.
The central bank has to send signals
All this does not mean, however, that interest rates in the euro zone have to remain so low in the long term and that the ECB should make its bond purchases permanent in the interests of cheaper refinancing options for the member states. A signal from the central bank that it remains vigilant would certainly be appropriate, not least to dampen consumer and business inflation expectations. After all, inflation in some euro countries is even higher than in Germany.
Nonetheless, it cannot be overlooked that monetary policy in a networked, globalized and very heterogeneous currency union is significantly more complex than was the case in the largely domestically oriented nation-states of the post-war world. It is possible that future generations of economists will come to the conclusion that a reasonably precise control of inflation has not only made little sense, but has become completely impossible.
The direct inflation control should then be placed in the same moth box in which the monetarists’ money supply control has been for some time.
More: Governing Council member warns of inflation risks – interest rate hike possible before bond purchases end