Germany is facing a severe recession in winter with record inflation at the same time. Drivers for both are energy prices, above all gas and electricity.
The evil letters from the providers are beginning to reach the people. The average family suddenly has to pay 500 euros a month instead of 100 euros. For many, the only way out will be to massively restrict their other consumption and thereby accelerate the economic downturn.
The situation in companies is just as dramatic. So far, many have been able to pass on their increased energy costs to consumers. But that will no longer be possible with reduced consumption and used up special savings from the Corona period.
This means that business models are on fire across the board – from small bakers to large industrial groups. Long-term decisions against Germany as a location are threatened there.
Many are shutting down their domestic production or relocating abroad. Investment plans for the climate-friendly conversion are put on hold. Everything revolves around just one question: How are we supposed to pay for the high energy prices?
A wave of insolvencies and relocations is threatening the substance of the German economy
In view of the inflation shock, the forecasts of the institutes still look quite light. A decline in gross domestic product of up to two percent is predicted for the coming year. But actually the recovery after the pandemic should have been pending.
Without the Russian war of aggression, we would have achieved robust growth of around four percent this year. Instead, we are experiencing the second major crisis in a short space of time. And: Energy costs will remain significantly higher for the foreseeable future and will probably not reach the pre-crisis level again in the long term.
In the medium term, the accelerated expansion of renewables will ease the situation. But over the next two years, the situation is dramatic. Everything must now be done to avert lasting damage from what would otherwise be the threat of deindustrialization.
The federal government in particular is required, because it is a national challenge. At the same time, only the federal government has the fiscal flexibility to react quickly and appropriately.
He must once again set up a protective shield for households and companies. A wave of insolvencies and relocations is threatening the substance of the German economy. The state must fight against this with all its might.
This can be done with direct payments, tax breaks and grants to those who are particularly affected. But that will at best get us through the winter, the energy price development resulting from the shortage of gas and the design of the electricity market threatens to be a permanent burden. Therefore, even in the short term, direct price interventions will not be possible.
The gas supply freeze is shaking the economy and society, and an emergency situation is to be declared for such cases
A price cap for basic consumption has been agreed for electricity. The solution for gas is still completely open. The commission responsible will put proposals for implementation on the table by mid-October.
The financing will not be a sure-fire success. In contrast to the electricity market, there is no direct access to the surplus profits of the crisis beneficiaries in the gas sector, because most of them are located abroad.
This would leave a large part of the bill with the federal government if it wanted to cover the difference between the market price and the discounted end customer price for basic consumption. Tens of billions of euros are to be estimated for this, in addition to the costs for the other aids.
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How is that supposed to be paid for? In the current situation, which is rightly seen as a turning point, we should use the flexible elements of the debt brake, as we did during the pandemic.
The gas supply stop initiated by Putin is a significant exogenous shock that is beyond the control of the German state and hits the economy and society to the core. It is precisely for such cases that the declaration of an emergency situation is provided. We would all have wished that we didn’t have to make use of this exception clause again immediately after Corona. But Putin leaves us no other choice.
There are also other financing proposals – from an “energy solo” to corresponding cuts elsewhere in the budget. However, no matter how worthy of discussion some of these ideas may be, they take far too long to implement and – like a new tax in a recession – are economically questionable.
There is immediate pressure to act. This means that credit financing for at least part of the upcoming crisis costs via the federal budget is unavoidable.
How inflationary additional government spending is depends on how it is used
Of course, the counter-arguments must be taken seriously and weighted. The Federal Minister of Finance rightly points out that an expansive fiscal policy can appear questionable in the event of a supply shock. At first glance, this seems convincing.
We are currently suffering from supply shocks. Even with constant demand, they drive prices up. And if we continue to fuel demand with new debt now, inflation can only get worse.
But how inflationary additional government spending actually is depends crucially on what is actually supposed to happen with it. No one is seriously calling for a broad-based, Keynesian-inspired stimulus to aggregate demand right now.
Nobody seriously wants to hand out helicopter money or consumer vouchers, cut consumption taxes across the board or anything like that. That would be completely counterproductive. Instead, it is specifically about a protective shield.
In other words, the partial cushioning of a cost shock that would otherwise lead to a clear cut for households and companies and thus endanger the stability of the entire economy in the long term.
Such a measure is not inflationary. On the contrary: a price cap for the basic consumption of electricity and gas directly reduces the consumer price index. This reduces the pressure on the collective bargaining partners and indirectly on the European Central Bank.
Investment is the only viable way out of the supply shock
Further interest rate hikes could be avoided, which would benefit the construction industry and, ultimately, public finances. Investments do not have to be inflationary either, because they not only generate demand, but also lead to an expansion of production capacities. Ultimately, investments are the only viable way out of the supply shock, so their financing must not be up for grabs.
Inflation is one of the greatest economic evils of all, especially for people with low incomes and small assets. Nobody can have an interest in prolonging or worsening inflation through wrong policies.
But properly understood economic policy can prevent the collapse of the German economy in the crisis, stabilize structures that are absolutely worth protecting and, quite incidentally, combat inflation.
To do this, politicians must now act forcefully and purposefully, and that is precisely why the debt brake must remain suspended in the coming year.
The authors: Michael Huether is Director of the German Economic Institute (IW). Jens Suedekum is Professor of International Economics at the Heinrich Heine University in Düsseldorf.
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