Business cycle and inflation: interest rates must rise – economy

It’s actually good news for workers. Aldi wants to raise the minimum wage, from June instead of the current 12.50 euros, 14 euros per hour should be paid. The reason for the sudden generosity of the discount chain known for its thrift is the skyrocketing inflation. For the same reason, IG Metall is now demanding 8.2 percent more wages for employees in the steel industry in the coming wage round. And Reiner Hoffmann, still head of the German Trade Union Confederation (DGB), is pushing for significant wage increases because of the price hike.

What is individually pleasing for the individual – namely: more pay for the hard work – is in this case dangerous for the economy as a whole. Because an enormously high inflation of around seven percent, at least by German standards, together with significant wage increases, can set a so-called wage-price spiral in motion. Inflation is high, so wages are rising significantly, making goods and services more expensive, companies raising prices, which fuels inflation again, which in turn leads to higher wages – in the worst case it will continue like this.

Inflation and stagnation together are a threat

The problem: once such a spiral movement has started, it is difficult to stop. That’s how it was in the old Federal Republic in the 1970s, when there were sometimes double-digit percentage wage increases and high inflation – back then it was the oil price shock that triggered it, today it’s the suddenly rising energy prices.

What makes things so dangerous today is the state of the global economy. After two years of a global pandemic and more than two months of war in Ukraine, the economy fears a significant decline, if not a recession. Economics Minister Robert Habeck has now had to significantly reduce growth expectations for Germany. Experts | like that of the DIW see further enormous risks for the German economy, especially if gas deliveries from Russia should soon stop altogether.

The high dependency on Russian energy supplies is now taking its revenge, especially for German companies. Corporations like BASF, which recently relied entirely on cheap Russian gas, are now complaining the loudest. There are also major problems in the global supply chains. The pandemic already led to serious difficulties here, with semiconductors becoming scarce worldwide. The Russian attack on Ukraine and the Corona disaster in China have further aggravated the situation. The demand for certain goods is therefore partly there, but there is less supply due to production difficulties – this also causes prices to rise.

High inflation and weak economic development are a toxic combination. Economists refer to this situation as stagflation, i.e. a combination of economic stagnation and high inflation. There is currently a great danger that Germany and Europe will get into this situation and then not get out of it so quickly (inflation is also high in the USA, but the economy is booming).

It would be all the more important that the European Central Bank (ECB) and politicians take courageous countermeasures. But so far they haven’t. On the contrary: the Berlin traffic light coalition is launching relief packages that are intended to strengthen purchasing power, but which economists believe could further fuel inflation in this situation. Christine Lagarde, President of the ECB, is also strangely reticent. Shortly before Easter there was talk of interest rates rising again, possibly in the summer, but Lagarde left open when exactly.

It’s clear that the situation is complicated: Every interest rate step is good against inflation, but bad for the economy and for strained national budgets, especially those of the southern European EU countries. Now that the ECB has pursued its low interest rate policy for far too long and did not tighten the reins when it would have been easier to do so is taking its toll. Nevertheless, a clear signal from the ECB in the fight against inflation is now important.

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