Saturday 30th October 2021
A clear trend? No!
Inflation doesn’t spread like a virus
A comment by Roland Lindenblatt
An inflation rate of now 4.5 percent gives many headaches. But it doesn’t have to be. Because there are clear reasons why inflation will soon weaken again.
Inflation rose to 4.5 percent this month. Another increase, it was 4.1 percent last month and 3.9 in August. Is that already a clear trend as with corona infections, which are increasing exponentially – i.e. also in larger and larger jumps in the same time interval?
No. Because inflation doesn’t spread like a virus. There are clear reasons for the high inflation. They will lead to slightly higher inflation rates in the medium term than in previous years with very low price increases and even short-term deflation, but also to the fact that inflation will weaken again from spring onwards.
Energy prices drive inflation
All you have to do is look at what Germans spend their money on. Because on the basis of these expenses of an average German, inflation is also calculated in this country. 8.5 percent is spent on food, around 30 percent for other goods, 20 percent for rent and another 30 percent for other services. However, around a tenth of the expenditure is spent on energy that people use to heat their homes and drive their cars.
Of all these prices, those for energy in particular have risen – by 18.6 percent compared to October 2020. There are three main reasons for this: The first is a purely statistical one. Energy prices fell to a low last year, and this year we are now comparing the high prices of this year with the extraordinarily low prices of last year. This leads to quite high inflation, but also to the fact that inflation will fall in the coming year if one compares the high prices of tomorrow with the already high prices of today.
The second reason for the high energy prices is the great demand during the economic upswing and a shortage of supply by oil and gas providers. It is difficult to predict how energy prices will go on in the future, but they will not continue to rise forever, simply because oil and gas suppliers have no interest in stifling the upswing that is bringing them so many buyers through high prices. Some industry experts are even talking about the fact that energy prices have reached a plateau.
The third reason is the ever faster conversion to a climate-neutral economy with additional taxes and high CO2 prices. Nothing will change that. But that is not enough on its own to keep energy prices at similar highs to current highs.
With delivery bottlenecks, inflation rises
What about the other things that people in Germany buy, the 40 percent of spending on other goods, for example? Or those for services? Groceries are around 4.4 percent more expensive than in the previous year, services 2.4 percent.
But even with these price increases there is again a statistical effect. A large part of the goods is affected by the VAT cut from the previous year. Between July and December 2020 it was 16 percent instead of 19 percent. That led to price cuts last year. Between July and December of this year, VAT is back at the old rate of 19 percent.
So high prices are compared with fairly low prices. This results in a sharp rise in prices, i.e. high inflation. In the coming year, this effect will also disappear again when prices with a VAT of 19 percent are compared with prices with a VAT of 19 percent. To understand this effect, it is sufficient to take a look at the inflation rates before July of this year.
You could stop here and say that high inflation will disappear permanently due to these base effects. But that would not be entirely correct either. After all, it is not just VAT and energy prices that result in higher prices.
Many companies want to produce more again, but they cannot. The producers of many preliminary products cannot keep up with their deliveries. Wood, screws, computer chips – many products are in short supply. There are also not enough ships that can move all these goods around the world. Transport prices from China to Germany have increased almost eightfold. The longer it stays that way, the more manufacturers will pass on the price increases for intermediate products and imported goods to their customers. As a result, prices will also rise in the coming year. But that, too, can change again if the global movement of goods slowly normalizes again in the course of the coming year.
There is no inflation without rising wages
In order for inflation to remain permanently high, inflation would have to drive itself higher and higher, just like a virus spreads when more and more infected people infect more and more healthy people. In the case of inflation, this effect is called the wage-price spiral: prices rise, employees demand higher wages and then prices continue to rise because people spend all their money on scarce goods, whereupon employers raise wages again.
But there are still very few sectors in which employees are scarce. Unemployment is even higher than it was before the crisis. Several hundred thousand people are still on short-time work. In such circumstances, it is difficult for unions to enforce higher wages. Workers tend to be scarce when the baby boomers retire and people are sought across the board and across all sectors. This effect drives inflation, but not this year or early next year.
In a few years’ time, however, it will ensure that wages rise and companies pass on the higher wage costs through higher prices. That could lead to slightly higher inflation over the long term. But that is not an effect that is currently emerging.
In addition, just as society can fight the spread of a virus with lockdowns or vaccinations, the ECB could keep inflation in check with a tighter monetary policy if a wage-price spiral really starts. It is not currently doing this, which quickly leads many commentators to criticize the ECB. But that’s okay too: The ECB can do little to counter inflation caused by supply bottlenecks or tax increases, but it could stifle the upswing as it did after the financial crisis. She will hardly do that.
We will therefore have to live with high inflation rates for a few more months, but almost everything indicates that inflation will fall again in the coming year. Zero percent or one percent inflation may no longer be an option, but rather inflation above two percent. It is not dangerous. Above all, however, it is not an unchecked upward trend.