Following Russia’s invasion of Ukraine, the outlook for the German economy has deteriorated. High energy prices are fueling inflation and uncertainties regarding the further course of the war and energy supplies are weighing on economic development. A decline in economic output in the second quarter of 2022 would therefore come as no surprise. Economic indicators such as the ifo business climate index and the GfK consumer climate index have been pointing to weaker development since the start of the war. Between January and March, gross domestic product has already increased by only 0.2 percent.
The economic risks for the German economy are enormous. In addition to the war, the widespread lockdowns in China are also putting the brakes on the economy. Above all, the already existing supply bottlenecks are thus being further exacerbated. German industry’s order books are still full, but the shortage of materials is severe. In addition, in view of the uncertain global political situation, some companies are trying to replenish their inventories, which further increases the shortages of inputs. Services, which suffered greatly during the pandemic, are less affected by international tensions and supply shortages. In addition, the increasing easing of Corona protection measures is having a stimulating effect. However, high inflation is reducing purchasing power and thus slowing growth in consumption.
Inflation is increasingly becoming an additional drag on the German economy. Energy prices are likely to remain elevated for the foreseeable future. Inflation, which has so far been driven to a significant extent by energy prices, is thus likely to recede only slowly. Consumer prices are expected to rise by more than six percent in the current year, which would be the highest rate in 40 years. There is also cause for concern because prices are rising not only for energy, but also for other goods such as food. In addition, problems with international supply chains have driven up the cost of inputs, and many companies are able to pass these on to consumers in the face of still solid demand for the time being.
Time and again, the European Central Bank has been accused of holding on to an expansionary monetary policy for too long and thus being partly to blame for high inflation. Many of these accusations are exaggerated. It is true that the ECB has to accept the accusation that it underestimated the risks of inflation. But the sharp rise in prices is primarily due to factors that have nothing to do with monetary policy – such as the gratifyingly rapid economic recovery from the Corona pandemic, expansionary fiscal policy in the U.S., lockdowns in China and now the war in Ukraine instigated by the Russian president. What cannot be dismissed, however, is that such extraordinary events are more likely to lead to stubbornly high inflation in an environment of low interest rates and securities purchases. With economic recovery stalled in many countries and high inflation rates, the ECB now faces the balancing act of curbing inflationary pressures without further worsening the economic situation. In addition, the euro member states are not affected by war and inflationary pressure to the same extent. Germany, for example, could be more affected economically than France or the Netherlands. All the more reason, therefore, for Germany and the euro zone as a whole to increase the productivity of the economy by investing in the future. In the medium term, this would be one of the best ways to counter low interest rates and inflation risks.
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