Berlin Volker Wieland sees dark times ahead for the German economy. “The prospects have deteriorated drastically,” he told Handelsblatt. Wieland is a member of the Advisory Council for the assessment of overall economic development, commonly known as “Wirtschaftswise”.
The Council cut its economic forecast significantly on Wednesday in view of the Ukraine war. In November 2021, the experts had forecast economic growth of 4.6 percent for the current year, now they only expect 1.8 percent. “This is almost exclusively due to the consequences of the Russian attack on Ukraine,” explained Wieland.
Nevertheless, an embargo would place a heavy burden on Germany due to its high dependence on Russian natural gas, oil and hard coal supplies. Therefore, “all levers must be set in motion” in order to prepare for a possible end to deliveries. These included, among other things, gas supplies from other sources and longer operating times for nuclear power plants. “The quicker we can achieve this over the course of this year, the greater our ability to act,” stressed Wieland.
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Read the full interview here:
The prospects have deteriorated drastically. In November last year, we forecast economic growth of 4.6 percent for 2022. Now we expect only 1.8 percent. This is almost entirely due to the aftermath of Russia’s attack on Ukraine, particularly soaring energy prices, high levels of uncertainty weighing on consumption and investment, and new supply chain issues.
Could the shock for the economy be bigger than in the corona crisis?
We don’t currently expect that. The damage to the economy should become particularly apparent in the coming weeks. After that, people are likely to spend more money again if the corona restrictions continue to fall, which supports the economy. For 2023 we expect growth of 3.6 percent. But uncertainty is extremely high and downside risks dominate.
Which one exactly?
The war could last a long time and even expand. Energy prices could rise sharply again and remain high for longer than expected. In contrast to the corona crisis, this recession would be characterized by very high inflation. Neither monetary nor fiscal policy can compensate much. Economic development would not go down as low as during the lockdown in spring 2020, but it would not pick up again as quickly as it did after the opening.
How will energy prices develop?
Energy prices are likely to remain elevated through 2022 but decline in 2023. This is shown by the activities on the energy exchanges. But scenarios with significantly higher prices are not unlikely. And there are extreme regional differences. While the price of natural gas has barely increased in the US, it has multiplied in Europe, which is heavily dependent on Russian pipeline gas supplies.
Are reliefs such as the 300 euro energy price flat rate and lower taxes on fuel that the federal government has decided to suffice?
I don’t think much of this relief package. The big rise in energy prices is making Germany poorer. These reliefs only redistribute what has to be financed again through debt and later higher taxes or inflation. It would have made more sense to only provide targeted support to needy households if they actually have to shoulder higher heating costs or travel expenses.
Completely different spheres of prices would be reached with an embargo on Russian energy. Could the German economy cope with that?
The German economy has already coped with a lot, including very severe recessions. And it would also cope with a delivery stop from the Russian side, for which one urgently needs to prepare, as well as its own embargo. Due to the high dependence on Russian natural gas, oil and hard coal supplies, Germany would fall into a deeper recession. In any case, that would be a heavy burden. In addition, unlike many other countries, we are still well below the pre-Corona crisis level of 2019.
Wouldn’t the damage be far too great if entire production chains collapsed?
A discussion that only focuses on a yes or no to an import embargo is misleading. We are in what is likely to be a long conflict with Russia. One has to assume that Vladimir Putin will use a supply freeze against Germany when it will do us the most harm and benefit him the most. Therefore, all levers must now be set in motion to prepare for it and to minimize the possible damage.
That would be?
Gas supplies from other sources, filling of gas storage facilities, lignite and hard coal power generation instead of gas, longer operating times for nuclear power plants, accelerated implementation of renewable energies, use of savings opportunities, change production chains. The quicker we can do this over the course of this year, the greater our ability to act.
Assuming these extremes don’t occur, what is your expectation for the inflation rate?
Our forecast assumes an increase of 6.1 percent this year and 3.4 percent next year. The same applies here: it could get much worse if energy, commodity and food prices increase even more. Producer prices have risen sharply, and companies will often pass this on to their customers.
What needs to be done about it?
Inflation is the responsibility of the central bank. The European Central Bank (ECB) has to raise interest rates. So she has no other choice.
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Uncertainty is currently very high. Why should the ECB commit to a course now?
We see a huge increase in inflation expectations. As a result, real interest rates have fallen to below minus six percent. Banks that park their money with the central bank have to pay a fee of 0.5 percent due to the negative deposit rate. When real interest rates are so much lower, one cannot seriously argue that there would be a problem if the ECB scrapped its negative deposit rate and turned the base rate at which banks borrowed from it into positive. That would at least be a first step towards a turnaround in interest rates. Even then, monetary policy would remain very loose and support demand.
>> Read here: ECB boss Lagarde sees permanently changed inflation dynamics
Will inflation stay high in the long term?
We only forecast the years 2022 and 2023. However, I do not believe that inflation will fall back to two percent in 2024. Market expectations are three percent. If the ECB tightens adequately, it can bring inflation back to 2% over the longer term, but that will be a major challenge. Tightening is not as easy as loosening.
Is a scenario like the stagflation in the 1970s looming?
Further sharp rises in oil and gas prices, a halt to supplies or an embargo would throw us into a recession with even higher inflation rates, which would be very similar to what happened after the Yom Kippur War and the oil embargo in the 1970s.
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