Prices rise sharply: “Interest rate hikes would destroy prosperity”

Prices are rising sharply and calls for a turnaround in interest rates by the ECB are getting louder. But that would be a mistake, says economist Florian Kern. The reason: At present “there is no actual inflation”. ntv.de spoke to the director of the think tank “Department Future” about the causes of the sharp rise in prices, the risk of inflation through compulsory corona vaccination and about how the base effect and happy hour are related.

ntv.de: Since the summer the prices in Germany have increased significantly. In the meantime, there are even warnings of galloping inflation. Is it time?

Florian Kern: No. Galloping inflation is a nice term to explain exactly where we are not. Underneath you imagine someone who rides his horse very quickly – over and over again. And we don’t see any signs of this “always going on” at the moment.

Despite some strong increases in prices?

The price increases that we are currently seeing are due to the supply. There are two possible triggers for rising prices. One is demand. That means: people have more money in their pockets – for example through higher wages. You can therefore initially afford more, so the demand increases, and this higher demand leads to rising prices. The second reason is a price increase, which has to do with the fact that something affects supply, production.

And is that currently the case?

We can see this in the rising energy prices, for example, which make the production of many goods more expensive. There are also disruptions in the supply chains triggered by the pandemic, which are still having an impact. We are in a transition phase – and we have to go through it.

Many economists also point out that the recent rise in the annual inflation rate is largely due to a change in statistics due to price movements a year ago, the so-called base effect. Can you explain that in more detail?

It’s like walking into the cocktail bar during happy hour. Suddenly it ended and all drinks are now twice as expensive. But they’re still as expensive as they were before happy hour. And that doesn’t mean that prices will double again in the next hour. We have such an effect in Germany because of the temporary lowering of VAT, which led to price declines last year. And this year there is the opposite effect with higher inflation.

Which brings us to the crucial question that is also being discussed in the European Central Bank. When will inflation rates be in the green again?

Florian Kern is director of the “Department Future” think tank.

(Photo: Future Department)

It’s a bit like looking into the crystal ball. In any case, it will be significantly less in January because then the base effect will no longer apply. However, geopolitical factors that affect energy prices also play a role. Russia has troops stationed on the border with Ukraine, it is not clear when gas deliveries through Nord Stream 2 will begin. At the same time, there are fewer deliveries of liquefied gas from the USA. All of this can ensure that energy prices continue to rise. But it is very likely that from July next year the price increase will again be close to the two percent mark.

A classic means of fighting inflation, however, is the rate hike.

Tighter monetary policy is indeed the right tool to fight inflation. But right now there is no actual inflation. What we are currently seeing are supply-related price increases. It would be a mistake to react to higher energy prices and disrupted supply chains by raising interest rates. At the Konrad-Adenauer-Stiftung – certainly not a left-wing think tank – I saw a very good definition of inflation: We are dealing with inflation when the price level rises across the board over a longer period of time. And that is currently not the case.

What doesn’t change that: Price increases cost prosperity, you can afford less.

The question is, what increases the prosperity of an economy? Will a rate hike mean that Russian President Vladimir Putin will send more gas to Europe and that freight rates for container ships will fall? No. A rate hike would be counterproductive at the moment and destroy prosperity. It would work in the areas that react to the interest rate level. Higher interest rates could send entire industries into recession and thus increase unemployment.

But thanks to the ECB’s loose monetary policy, those who save for their old-age provision, for example, hardly get any interest.

There is a quip from Neel Kashkari, president of the Minneapolis Fed regional central bank: “Americans’ most important asset is not their retirement savings or their home, but their job.” In other words, what’s the point of a rate hike if you lose your job for it? For the average German, an interest rate hike would currently mean that the risk increases that their next wage increase will be lower or that they will even become unemployed. If, on the other hand, you have a large fortune or a very secure job, you should benefit from an interest rate hike.

Especially since not everyone has savings.

According to the Bundesbank, the average German has financial assets of around 17,000 euros. An increase in interest rates by one percentage point would, in purely mathematical terms, mean 170 euros a year more income for him. That is negligible in relation to the workplace risk.

Let’s come back to inflation. At the beginning you spoke of the possibility that an economy could slide into inflation because of the demand side. This could happen as a result of a so-called wage-price spiral – that is, employees pushing through higher wages across the board, whereupon the companies raise prices in return, whereupon employees push through higher wages, a chain reaction occurs and inflation gets out of control. Isn’t there currently a risk that the high rates of price increase will increase fear of persistent inflation and that such a spiral will therefore be set in motion by high wage demands?

That could happen. And that’s exactly why central bankers need to explain why it is currently wrong to raise interest rates. The Bundesbank is used to arguing from a different perspective. But now there is political pressure that interest rates should be increased – and the Bundesbank is in the role of arguing for low interest rates. She hasn’t really found her way around it yet.

Can you still give the all-clear?

There is currently no evidence of a wage-price spiral. This is shown by a look at the increases in newly negotiated wages. In the third quarter, they were on average 1.35 percent higher than a year ago. This is the lowest value since the euro was introduced in 1999. Since the common currency existed, the risk of a wage-price spiral, measured against current wage increases, has never been as low as it is now. We are not in the situation where the labor market would be completely emptied and absurd wage demands could be enforced.

So are there currently no inflation risks?

There are. But these are not the current rate of price increases, but things that are discussed in politics. One example is the general compulsory vaccination. There may be good reasons for this. But it could lead to a real shock on the labor market if, for example, numerous nurses are no longer available and new hires have to take place as soon as possible at significantly higher wages. Such a development can be seen in the USA: Individual hospitals have increased the wages of nurses by up to 65 percent. This becomes a problem if this does not happen in individual industries, but on a broad basis.

The new traffic light coalition has raised the minimum wage to twelve euros an hour. Is that also a risk?

She did this without the independent minimum wage commission. This was used to determine how high the minimum wage can be without causing a wage-price spiral. The increase to twelve euros was made for political reasons and may well lead to price pressure in Germany. Incidentally, the Bundesbank and the ECB will take a closer look at this development. It is interesting to see how the wage agreements will turn out in the coming year and whether the minimum wage will then continue to rise sharply due to the high rate of price increases. Christian Lindner proposed an inflation brake a few months ago. It wouldn’t be bad if politicians could see what their decisions mean for inflation.

Jan Gänger spoke to Florian Kern

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