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Global Economy

Inflation in Germany: where the price increases come from – and what can be done about it

Consumer prices in Germany have risen more sharply than they have in decades., This is causing concern for many., Two economic experts explain where the inflation is coming from – and what can be done about it.

    Consumer prices in Germany have risen more than they have in decades. This is worrying many. Two economic experts explain where the inflation is coming from – and what can be done about it.

Life in Germany has become more expensive: the post office has increased postage, the prices for vegetables in the supermarket have gone up, and you have to dig deeper into your pockets when it comes to heating costs.

The inflation rate in Germany reached its highest level in three decades at more than five percent. The Germans fear for their financial security.

The concern that this price increase triggers among Germans is even greater than that of the coronavirus pandemic and the Ukraine crisis. At least that is the result of the "Security Report" from the Center for Strategy and Higher Leadership and the Institute for Public Opinion Allensbach.

Inflation worries the Germans

A total of 1,090 Germans aged 16 and over were surveyed in January. 70 percent stated that they were worried about the sharp rise in prices.

Every second person feels personally threatened by the consequences of inflation – a year ago that was not even every third person. "The current price increase is very high compared to what we have experienced in the last few decades," says economist Karl Brenke.

But the same phenomenon can also be seen in other countries in the euro zone and in the USA. Inflation there was as much as seven percent at the end of the year.

Increased energy prices as a cause

"The decisive factor for these inflation rates are the energy prices," says expert Brenke. The prices for crude oil and gas would have a strong impact and drove up inflation in the individual countries.

Economist Kerstin Bernoth agrees. "Geopolitical conflicts such as tensions with Russia play a role in energy prices, but the energy transition is also currently making fossil energy more expensive," she says. Brenke confirms: "German politics is currently focusing on increasing fossil energy prices, and CO2 taxation took effect at the beginning of the year". In Germany, the state has pushed inflation even further.

In the current situation, the government can hardly do anything to counteract the rise in oil and gas prices. "One can only wait until the saber-rattling from Russia stops and diplomatic solutions are found," said Brenke.

Expert Bernoth also agrees that it remains to be seen whether the previously more sectoral price increases, such as in the energy sector, will spread across Europe.

The pandemic also plays a role in price increases from the experts’ point of view. "There are and have been delivery bottlenecks in several sectors," reminds Bernoth. The lack of computer chips in particular has been widely cited, but other material is also lacking in the manufacturing sector.

Sneakers and bicycles can be affected, as can dishwashers and spare parts for cars. During the lockdown, production and logistics capacities were shut down, and companies could not keep up with the rapid increase in demand.

“Households saved a lot during the pandemic because they were unable to spend anything in the lockdown. Strong demand due to the post-pandemic recovery and savings is now meeting tight supply,” analyzes Bernoth. Frequently, however, there are still problems with transport – there is a shortage of ships and containers, and freight rates have risen.

Brenke suspects that another factor could affect the situation: "The minimum wage in Germany will be increased by six percent this year," he recalls.

Since the beginning of the year, the minimum wage has been EUR 9.82 per hour, and it will rise to EUR 10.45 as planned in the second half of the year. A draft law by the Federal Ministry of Labor envisages an increase to 12 euros in 2022.

Worry about the price-wage spiral

Brenke sees jobs at risk as a result. "The minimum wage was first introduced when inflation was relatively low, so consumers accepted a minimum wage," he says, looking back.

Nevertheless, the Germans went to the hairdresser just as often, did not forego taxi rides or canceled newspaper subscriptions across the board.

"But if the minimum wage increase now takes place in an environment of high inflation, consumers will have to pay more attention to their spending," explains Brenke. Some are then likely to reduce their spending – and that in turn could cost jobs.

Higher prices due to higher wages

"It would also be a problem if high inflation triggered a price-wage spiral," warns Brenke. What is meant by this is the following scenario: The trade unions are demanding higher wages due to higher prices. If an employer has to pay its employees more, this in turn leads to higher prices in the end.

"If the price increases that are now coming from outside are used by trade unions to push through higher wages, then the inflation will come later to a large extent from within," says Brenke.

But the experts see another player ahead of the German government: "The central banks are primarily responsible for price stability, that's not the mandate of the state," emphasizes Bernoth. Politicians can intervene more sectorally and temporarily reduce taxes on certain products or pay certain subsidies.

Low-income households are disproportionately affected by inflation. "Politicians can set themselves the task of doing something so that there aren't that many households on the subsistence level," says Bernoth.

ECB could raise interest rates

Inflation must be taken very seriously. "The central banks must now be very vigilant in the coming months and act if necessary," stressed Bernoth.

There are still doubts as to whether and when the European Central Bank (ECB) will raise interest rates. "If the general price level and also wages continue to rise in the coming months, that should be necessary," estimates Bernoth.

Even the experts find it difficult to predict when prices will fall again. "There are very big uncertainties right now," says Bernoth. The production backlog is likely to subside soon, and there is still no improvement in sight for energy prices. "Prices will tend to fall over the course of the year," she estimates.

About the experts:
Prof. Dr. Kerstin Bernoth is Deputy Head of the Macroeconomics Department at the German Institute for Economic Research Berlin and teaches at the Hertie School of Governance Berlin. The research interests of the economist lie in the area of empirical financial market research, monetary and fiscal policy and financial stability.
Karl Brenke is a researcher in the economic policy department at the German Institute for Economic Research Berlin (DIW). He studied sociology, economics and statistics at the Freie Universität Berlin.

Sources used:

Center for Strategy and Higher Management: Security Report 2022, Interview with Prof. Dr. Kerstin Bernoth, Interview with Karl Brenke

    Center for Strategy and Higher Management: Security Report 2022Interview with Prof. Dr. Kerstin Bernoth Interview with Karl Brenke

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