Will stagflation shape the next few years?

Because no one knows how long the conflict will last, companies have no indication of how long the supply shock will last and how much further it might escalate. The economic and global economic consequences are also unclear.

Based on a historically high order backlog and the prospect of an economic upswing in the course of 2022, companies are now experiencing multiple cost shocks.

Energy prices are at record highs. Critical raw materials, some of them from Russia, are being offered at unexpected prices, with it being unclear whether the desired quantities can even be available in the desired time. In the short-term search for alternative sources, the supply chain law can prove to be an obstacle.

Capacities built in Ukraine are idle

Labour-intensive production capacities built in Ukraine, such as wire harnesses for the automotive industry, are idle; the supply chains are disrupted, sometimes interrupted.

Disrupted (rail, truck) and congested (container shipping, air freight) logistic systems exacerbate the problems by extending availability risks to many internationally traded intermediate products. All in all, a broad slump in production is conceivable, with the same extent as in the 2020 pandemic lockdown, but probably longer.

There is a threat of a standstill in the car industry based on the division of labour, which will have an impact on the economy as a whole. It is already important for companies to secure and manage liquidity, which can lead to short-term flexible expenditure, especially investments, being postponed.

Employment is also likely to suffer; the short-time allowance could again be an important instrument to cushion the crisis. As a result, private households will lose income, as they did during the pandemic, and medium-term expectations will deteriorate.

However, private consumption would not only be impacted by the loss of income, but also by the purchasing power effects of the inflation that is already apparent. In addition to the supply shock, there is a threat of a crisis in aggregate demand. What is likely to begin as an economic slump or even a recession this year could become a permanent burden on the growth dynamics of all European industrial economies.

In a phase in which these are already being massively challenged by the conversion to climate neutrality, the digital transformation and the advancing demographic aging, there is now an additional threat of fundamental geopolitical and geoeconomic uncertainty.

Germany must become competitive in terms of tax policy

Stagnation could become the sign of the coming years. Just as the federal government has implemented a change of course in foreign and security policy, which, in supposedly safe times, annulled lovingly cherished ideological positions of the centre-left spectrum, other policy areas must also be subject to the revision proviso of reality. Financial policy is particularly challenged in this crisis management.

This starts with financing the permanently higher defense spending. The planned special fund for the Bundeswehr makes procurement easier, but by circumventing the debt brake.

The mantra-like phrase that the debt brake would otherwise apply is now even less convincing than before. Although all potential savings are to be mobilized, they will hardly be sufficient to finance the investments that have been made or the tax cuts that are actually required.
However, in order to strengthen private investments in Germany for structural change, this must become competitive again in terms of tax policy. The abolition of the solidarity surcharge, reduced to corporate tax, would be one building block.

The adjustment of the actuarial interest rate for pension provisions in the tax balance sheet, which has been six percent since 1982, to the commercial balance sheet relevant for companies, currently 1.69 percent, would also significantly relieve the burden. It would also be helpful to have a directly effective, unlimited loss carryback that reduces current advance payments for income tax and corporate income tax.

Discounts at the gas station are not accurate

Automatic adjustment of the income tax rate to inflation would protect private households and partnerships alike from cold progression. This becomes all the more important in times of stagflation; Such an indexation – unlike case-by-case and arbitrary compensation – seemed like a reliable promise.

In the short term, households with lower incomes must be helped to cope with the high fuel costs. Here, subsidies – analogous to the heating cost subsidy – would be more targeted than discounts at the gas station, which relieve all drivers and are bureaucratically complex.

Fiscal policy is also called upon so strongly because path dependencies have a particular impact on energy policy. The decisions to phase out the generation of nuclear energy and coal-fired power generation make gas the central primary energy source in the transitional phase until demand is fully covered by renewable energies.

Since gas supply flexibility is low, at least in the short term, due to dependence on the existing infrastructure, efforts to become independent of Russian imports are concentrating on hard coal and crude oil. This can be achieved by the end of the year, but it will be very expensive in any case.
In order not to lose energy-intensive companies, some of which have shut down production because of the high energy costs, there is a need for action. One solution would be to transfer the idea of ​​climate protection agreements to the current situation.

Financial support could be used to open up ways for the companies concerned to adapt that would secure their existence and at the same time lead to climate neutrality. With a view to the jobs, this is always necessary. But for this, too, we need new flexibility in fiscal policy. Everything needs to be put to the test.

The author: Michael Hüther is director of the Cologne Institute for Economic Research.

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