Inflation: This is behind the Bundesbank’s warnings

DThe current month could mark an all-time low in Germany’s recent economic history. The Bundesbank is now anticipating an inflation rate of six percent for November. That would be the strongest price increase since the early 1990s. It is true that inflation is expected to decline again in the months thereafter. However, it could remain well over three percent for a long time.

The inflation warning is more emphatic than the central bank’s earlier admonitions of a five percent high. It coincides with the last few days of coalition talks, which will likely lead to a new government under the leadership of Social Democrat Olaf Scholz.

The economists also express concern that there could be a wage-price spiral, especially if the minimum wage is raised significantly, which is currently the topic of the coalition negotiations between the SPD, the Greens and the FDP.

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The traffic light coalition is planning to increase the minimum wage to twelve euros per hour in 2022. According to the German monetary authorities, this would have “non-negligible spillover effects” on the higher wage groups: “This should also increase wage pressure in the future,” says the Bundesbank’s monthly report.

Economically, Germany is threatened with the worst of all worlds. Economic growth has already weakened significantly recently due to the increasing supply bottlenecks.

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In addition, there are now the increasing numbers of corona infections, which are likely to slow down the dynamism in the service sector in particular. “The risk increases that the German economy will shrink in the fourth quarter,” says Commerzbank economist Ralph Solveen.

In the third quarter (July to September) the gross domestic product had increased by 1.8 percent. The only thing that separates Germany from the dreaded stagflation – the combination of economic stagnation and inflation – is the hope that growth will soon accelerate again in 2022.

“Hü-Hott situation”

The Bundesbank explains the inflation warning also with special effects. The six percent expected this month is due, among other things, to the fact that the VAT rate was lowered in the previous year. This is now noticeable as a base effect in the consumer price index and arithmetically driving inflation by 1.25 percentage points.

In addition, many consumer goods and services have risen dramatically. This is particularly noticeable in November 2021 for package tours, which are likely to push the inflation rate by half a percentage point compared to October.

Source: WORLD infographic

Even if the inflation data only shows a six before the decimal point this month, such a high value could spark old fears. The devaluation of money had disappeared from the consciousness of many German citizens as a social problem. A six percent shock followed by further high numbers could cause inflation expectations to stabilize.

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That in turn could lead to massive changes in behavior. Some consumers prefer to keep their money together in what felt like times of inflation, others try to buy big things in anticipation of even higher prices in the future.

In such a high and hot situation for consumers, it becomes more difficult to make reliable forecasts throughout economic life. In an environment of uncertainty, companies may be more likely to postpone their investments and large investors withdraw their capital and prefer to move to other exchanges.

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Economists are also warning of the long-term consequences of solidifying inflation. “Once started, goods price inflation is difficult to recapture. To end it, the increase in the money supply would have to be slowed down, or the central banks would have to raise interest rates, ”says Thorsten Polleit, chief economist at Degussa Goldhandel.

In the heavily indebted world, this could all too easily lead to a new financial and economic crisis, warns the expert. In the short term, inflation works like an economic problem remover, but in the long term the economic and social costs are very high.

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The longer the inflation phase lasted, the more severe this crash will be. “Above all, if the solvency of the states depends on access to central bank loans, the risk is particularly great that it will not be possible to get out of inflationary policy early on, with ‘wise foresight’,” he says.

Because not only the governments, but also the ruled would generally welcome the positive effects of the inflation policy at the beginning: The economy is stabilizing, unemployment is falling, and corporate profits are rising.

But at some point the day of reckoning will follow. And November 2021 seems to give Germany a little foretaste of what this reckoning day could look like.

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