Rising Prices: The Risks of Stagflation

There are many indications that the German upswing will stall in autumn. Experts warn of stagflation, a mix of stagnating economic activity and high inflation. How great are the dangers?

Empty country roads and highways on which at most cyclists are traveling – such images existed in the 1970s. At that time there were car-free Sundays because of the oil price shock. Because the oil cartel cut production, the price of oil doubled within two years. The result was an economic standstill with rising unemployment and rapidly rising inflation.

Energy and material costs are increasing

This so-called stagflation could happen again in Germany – at least temporarily. Once again, the massive rise in energy prices is threatening to stall the economy. Several data and indicators point to a slowdown in the German economic upturn in autumn. The business climate index of the Munich Ifo Institute recently fell for four months in a row. In August industrial orders collapsed by almost eight percent and production by five percent. Researchers and the federal government have just lowered their economic forecasts for the year as a whole significantly.

“Stagflation in the fourth quarter”

Jens-Oliver Niklasch, economist at the Landesbank Baden-Württemberg (LBBW), considers the mixture of rising prices and falling production to be “a toxic brew that smells slightly of stagflation”. Jörg Krämer, chief economist at Commerzbank, is similarly gloomy. “Currently, the material shortages, falling demand from China and a new wave of corona suggest that the German economy will barely grow in the fourth quarter,” he predicts.

At the same time, rising energy and material costs are likely to further fuel inflation. Even the more cautious Bundesbank does not rule out an inflation rate of five percent at the end of the year. In this respect, one could definitely speak of stagflation in the fourth quarter, says chief economist Krämer.

This also increases the risk of a so-called wage-price spiral. In the 1970s, the unions pushed through massive wage increases to offset the high price increases. In fact, they fueled inflation even more.

The situation on the job market is very different today

The first German trade unions are already demanding a strong “swig from the bottle”. The IG Bauen-Agrar-Umwelt wants 5.3 percent more wages. In addition, the minimum wage is rising – an adjustment to 10.45 euros in the coming year was planned anyway, the expected traffic light coalition even wants to increase it to twelve euros.

Sebastian Dullien, director of the trade union-affiliated IMK Institute, has not yet seen any evidence of a wage-price spiral. The union demands are no higher than in 2019, he says. “At that time, wages in the economy as a whole rose by almost three percent.” Unlike in the 1970s, there is currently no sign of rising unemployment. On the contrary: many positions cannot currently be filled due to the shortage of skilled workers. And: The situation on the labor market has recently improved, say economists.

Hope for a boom in the coming year

Several experts therefore consider the historical comparison to be absurd. “The current situation is by no means comparable to that of the 1970s,” says ING chief economist Carsten Brzeski. Both industry and consumers are now much less dependent on energy than they were 50 years ago. The US bank JP Morgan also reassured young investors in a study: “This is not the stagflation that your parents experienced.”

Most economists believe that the stagflationary tendencies are likely to decline again in the coming year. While the economic recovery is likely to pick up again, inflation is likely to decline. Many experts also expect fewer bottlenecks in semiconductors and other important preliminary products. “The empty warehouses of the companies and the abandoned orders speak for a strong increase in industrial production in the coming year,” says Thomas Gitzel, chief economist at VP Bank.

Central banks play an important role

Whether or not stagflation actually lasts longer depends on the central banks as well. In the 1970s, the US Federal Reserve failed to curb inflation. In the fight against stagflation, central banks are faced with a dilemma: with a loose monetary policy with low interest rates and extensive bond purchases, inflation may rise. If the central banks tighten monetary policy with higher interest rates, they may choke the economy.

Some experts warn of “green stagflation” in the course of the switch to climate-friendly production and CO2 neutrality. Economic stimulus programs for restructuring the industry, believes the economist Bert Rürup, a former “economic expert”, could drive inflation. At the same time, there is a threat of the economy stagnating for demographic reasons from the middle of the decade. “In two years the zenith in employment should be exceeded,” said Rürup. From 2026, around 130,000 fewer people in Germany will be of working age each year.