MACROECONOMICS

INFLATION IN GERMANY

GROUP – H
Karthik Pakki – 26
Kavya – 28
Mannan Mathur – 41
Mani Kumar – 42
Niharika Sabharwal - 45
 Index

Introduction --------------------------- 2

Current Scenario --------------------------- 2

Medium term outlook --------------------------- 5

Challenges --------------------------- 7

Policy Intervention --------------------------- 8

Managerial Learning --------------------------- 10

References --------------------------- 11

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Introduction

Germany plays a leadership role among the surrounding 19-member Eurozone countries. It has the
largest economy among European countries and has record low unemployment, optimistic
investors and strong Gross Domestic Product (GDP). But despite this bright outlook, there are few
issues like low wage growth, inflation, aging society and high current account surplus of concern
for Germany in 2019, in terms of its own future and that of other European nations.

Current Scenario

Over many years, Germany has been maintaining a real GDP growth of 2% annual average.
However, Germany’s economy took a plunge in the second half of 2018. This can be attributed to
certain disruptions in German’s automobile and chemical industries. These disruptions contributed
to the reduced growth rate of around 1.5%.

Economic Indicator Projections

2017 2018 2019 2020
Real GDP growth (%) 2.2 1.4 0.7 1.7
Unemployment rate (% ILO) 3.8 3.4 3.2 3.1
Employment growth (%) 1.1 0.5 0.7 0.4
Inflation (% headline) 1.7 1.9 1.4 1.8
Inflation (%core) 1.3 1.4 1.5 1.7

Source: Deutsche Bundesbank, Eurostat, Federal Statistical Office, Haver Analytics, and IMF staff calculations.

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 Following a similar trend to
that of other developed world
economies, Germany also
witnessed subdued inflation.
The inflation rate in Germany
by July 2019, was confirmed
at 1.7%. The food prices are
witnessing an increase in
prices, whereas the inflation
for energy and service sectors
has been eased.
Source: IMF

In any economy, inflation and

unemployment are strongly
related to each other. Germany
has witnessed a record low in
its unemployment. In other
words, despite relatively
slower growth, employment
picked up and in turn resulted
in growth in wage rates above
3%.

Source: IMF

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Source: Federal Statistical Office

It is also important to note that real wages have grown faster than productivity, which implies a
relatively strong cyclical position. The fast-paced urban cities are also witnessing rapid rise in
terms of the residential and commercial real estate prices. Interestingly, there has been a shift in
the country’s inflation basket. There have been significant changes in consumers' food choices. To
reflect these changes German inflation figures will be determined by giving more weight to
restaurant spending among many other categories.

German Inflation Basket Weighting (%)

Housing 32.5
31.7

Transport 12.9
13.5

Recreation, entertainment and culture 11.3

11.5

Food and non-alcoholic beverages 9.7

10.3

Restaurants and accommodation services 4.7

4.5

Health 4.6
4.4

Clothing and Shoes 4.5

4.5

0 5 10 15 20 25 30 35

2015 2010

Source: Federal Statistics Office

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In the month of January 2019, the consumer price index has been revised from the base year 2010
to 2015. The above graph, illustrate the changes in weights used for calculating inflation with the
items in inflation basket. According to Federal statistics office, the percentage expenditure in
income on food tend to be increasingly small among developed countries like Germany. Also,
there has been an increasing tendency towards organic foods change the dynamics of overall food
consumption. It is clear from the above graph, the weights used for inflation calculation for housing
and restaurants are increased. These changes are made to align with the rapidly changing consumer
behavior.

Medium term outlook

• As inflation increases, purchasing power of money declines which in turn leads to lower
consumption and lower GDP. High inflation can make investments less desirable, since it
creates uncertainty for the future and it can also affect the balance of payments because
exports become more expensive. As a result, GDP decreases further. IMF estimates that
inflation rate in Germany is expected to rise by 2.2 % by the year 2024 from 1.93% in
2018. This change from 2018 to 2019 is primarily due to food and energy. This hides the
fact that, against the background of high aggregate capacity utilization and considerable
growth in unit labor costs, the prices of other goods and services are increasing at an
accelerated pace. Excluding energy and food, the inflation rate is therefore likely to climb
from 1.2% this year to 1.8% in 2020. In 2021, it could reach 2.0%, measured by
Harmonized Index of Consumer Prices (HICP)
• GDP -
It is probable that aggregate capacity utilization, which is already at a high level, will
increase only slightly further in the coming years: gross domestic product (GDP) is
projected to grow at a marginally faster pace than potential output, the growth rate of which
is also in decline.

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 By 2024, the German GDP is expected to increase by 1.16 percent compared to the
previous year. Germany’s social market economy is one of the largest worldwide and
continues to thrive. One of the strongest industries in Germany is car manufacturing:
Several German vehicle manufacturers, like Daimler, Volkswagen, or BMW, are among
the major global market players and have brought in billions of euros in revenue in the past
years, fueling the economy for years to come.

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 • Fiscal space is expected to stay stable in medium term, in spite of fiscal policy taking a
expansionary turn in year of 2019. The budget of 2019 focuses on various measures to
increase family support and public investment alongside income tax relief – this will be in
a form higher basic tax allowance and correction bracket creep, this relief is going to
amount to .2 percent of GDP per year, which will provide impetus to moderate fiscal
expansion of 2/3 percent of GDP. For long term, there is projection that there will be a
decrease from 1.2 percent of GDP in 2018 to ½ percent GDP in 2021-2022, this will be
based upon the package of fiscal measure which was agreed upon the formation of coalition
in last year.

Challenges

Hyperinflation is probably the worst situation an economy can face. Not only does it destroy
output, but also destabilizes societies. The business costs soar, as the productivity reduces due to
an increase in wages and prices on an hourly basis.

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The Germans fear of letting inflation get out of hand. This fear, stems from the crisis of
hyperinflation in the year 1922-1923. Banknotes became useless to the extent where the workers
used to bring wheelbarrows with them to work to collect their wages and the children played with
bundles which was actually cheaper than the real toys. This history of hyperinflation in Germany
has led the economists and the people in general closely monitor the trend of inflation in the
country and the challenges that come along with it.

German inflation held steady during the start of the year amid a significant deterioration in the
economic outlook. Adding to these challenges, the European Central Bank (ECB), is constantly
facing hindrances in weaning the euro area off unprecedented stimulus. In order to improve
economic growth across eurozone, the ECB holds down the interest rates which disgruntles the
public as they receive low returns on their investment.

Besides inflation, the German economy as a whole is facing multiple challenges in respect of low
wage growth, budgetary surplus, and a high current account deficit.

Policy Intervention

As it is mentioned earlier, the inflation rate in July 2019 is at 1.7% and is projected to fall to 1.4%
in August 2019 (y-o-y). German inflation remained below the European Central Bank’s target level
of 2 percent (which was for the euro zone as a whole). Germany’s political culture is famously
inflation-phobic, preferring both tight monetary policy and balanced budgets.

While maintaining the inflation rate below the target level of 2 percent, Germany has other major
problems like slowdown in their GDP growth rate, as well as external risks surrounding trade
tensions and the Brexit process. Despite the growth slowdown, the output gap is assessed to be
moderately positive in 2019, reflecting several years of above-potential growth alongside still-low
potential growth (as a result of both slowing potential labor force growth and slowing contributions
from capital accumulation). The positive output gap is expected to lead to modest upward pressure
on core and headline inflation.

Germany’s key economic challenge is to raise its long-term growth potential while rebalancing its
economy.

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High wage growth and its effects on inflation

One such challenge that Germany faces in 2019 is improving wage growth for workers and low
spending. Household disposable income has stagnated for households in the lower half of the
income distribution, depressing consumption. After the global financial crisis of 2018, German
workers have accepted lower wage rates in return for job security. However, the current situation
has improved with the country now having a record low unemployment rate, 3.9% in 2018, along
with strong GDP growth. If the German workers received higher wages, they might be inclined to
spend more and save less, which would boost the German economy. This increase in wage growth
in Germany would further help other euro area countries as well because it would bring the
inflation rate in the euro area as a whole closer to the European Central Bank’s target inflation rate
and keep prices stable in the region.

Future outlook of high wage rates - Unfavorable demographics, low productivity growth,
technological change, and the energy transition are expected to weigh on growth over the medium
term. Growth is projected to decelerate to 1.1 percent by 2024 and the output gap is projected to
gradually close. Both headline and core inflation should reach 2.2 percent by 2022. With the labor
market expected to remain tight amid a declining labor force, wage growth should continue to
accelerate.

Budgetary Surplus and need for higher government spending

Germany has a budget surplus and its public debt ratio is decreasing rapidly with no room for the
government to increase public spending. German government now must have to choose how best
to allocate resources to its long-term investment initiatives, such as road construction, training
programs for the recent influx of refugees, quality childcare and afterschool programs, while also
saving money to pay for the pensions and health care of its aging population. With the highest
current account surplus (at 8% of its GDP) worldwide in dollar terms, the country exports more
than its imports. From this we can infer that, there has been more savings than spending, which
hampers the growth. With such high current account surplus, Germany has a significant challenge
in terms of reducing the need for the population to save for retirement by encouraging older
workers to stay in the workforce.

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Managerial Learnings:

German annual inflation remained below the European Central Bank’s target level in June 2019,
hence there will be no increment in the interest rates this year. While the German government has
reduced its debt to GDP to 60.90% in 2018, the forecast indicates it to get further reduced to 58.50
in 2019. This indicates the great confidence investors will have in the German economy and its
ability to pay off its debt, thus leading to higher growth opportunities as compared to the other
countries in the European Union. The graph below depicts the decreasing trend of the Debt to GDP
for Germany, this influx of money from investors may increase the inflation further. Although the
German government has the highest current account surplus, they should look for investors who
brings an innovation in services or manufacturing domains, this creating substantial employment
for the people of Germany.

The inflation rate in Germany was at 1.7 percent year-on-year in July 2019, up from 1.6 percent in
the as compared to the previous month, food prices increased while energy and services inflation
was at ease. For Germans, the diet is quite diverse, the food and beverage industry in Germany
offers much more for consumers. There are nearly 170 kinds of different foods for consumption,

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as the population is more receptive to the new culture and dietary trends. This industry is always
eager to respond to the changing needs of the society and provide the best standards, which
eventually causes the inflation due to the increasing demand. Government should look for scaling
the production and new opportunities in the food and beverage industries for its own as well as
export consumption.

In case of mild inflation, the wages of the workers should increase accordingly, if not the money
will not transfer from the workers to the business thereby reducing the total demand. Monetary
expansion and increase in the public spending will support the growth, but only for a short period
of time.

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References
• IMF Country Report No. 19/213 IMF – Germany
• World Economic Outlook - IMF 2019 Apr
• "government-debt-to-gdp," Tradingeconomics, [Online]. Available:
https://tradingeconomics.com/germany/government-debt-to-gdp.
• "German Inflation Rate Falls More than Expected," 29 08 2019. [Online]. Available:
https://tradingeconomics.com/germany/inflation-cpi.
• "industry-overview-food-beverage-industry," GTAI, [Online]. Available:
https://www.gtai.de/GTAI/Content/EN/Invest/_SharedDocs/Downloads/GTAI/Industry-
overviews/industry-overview-food-beverage-industry-en.pdf.
• "even-mild-inflation-is-risky," hurriyetdailynews, [Online]. Available:
http://www.hurriyetdailynews.com/opinion/erdogan-alkin/even-mild-inflation-is-risky--
31863.
• 3 Economic Challenges for Germany in 2019
https://www.investopedia.com/articles/investing/122115/3-economic-challenges-
germany-faces-2016.asp
• German inflation rate steady at 1.7% in January
https://www.ft.com/content/3c5a4d5a-248f-11e9-b329-c7e6ceb5ffdf
• German inflation rises to 2.1% in April, above ECB target
https://www.dw.com/en/german-inflation-rises-to-21-in-april-above-ecb-target/a-
48550333
• German lenders stick up for savers as ECB rate cut looms
https://www.theguardian.com/business/2019/sep/08/europe-central-bank-interest-
rates-recession-germany

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