There has been much buzz in the markets that Germany is on the verge of its most important shift since the crisis began. Two official comments have captured some imaginations. The first is that Jens Ulbrich, the head of the Bundesbank’s economics department, told parliament’s finance committee that going forward, Germany may have inflation rates “somewhat above the average within the euro area.” The second is that Finance Minister Schaeuble, who is most likely to replace Juncker as the head of the Eurogroup of euro zone finance ministers, backed wages demands to help reduce imbalances.
This is not far from the IMF’s advice. It not only has called on the ECB to cut rates, but last week, it also recommended that Germany accept some wage and asset price inflation as part of the process to re-balance growth.
Nevertheless there are good reasons to be suspicious of the arguments that Germany is casting aside its traditional strategy. One need not make gratuitous references Germany’s experience in the 1920s and 1930s. One need only to return to the post WWII situation, the high inflation, the lack of monetary credibility (American cigarettes as a means of exchange?) and the ideological response (ordoliberalism).
At the end of last week, BBK President Weidmann denied earlier press reports. He explicitly dismissed reports claiming that Germany would accept higher inflation as part of a broader re-balancing of European growth as “absurd”.
German inflation in April was 2.2%, having fallen from 2.9% over the past six months. German inflation is the lowest in a year. The euro area average is currently 2.6%. Given the weak growth in the region, including prospects of subdued German growth, and the fall in commodity prices, the risks of inflation are on the downside.
The kernel of truth in Ulbrich’s comments is that the Berlin Consensus essentially calls for the area’s debtors to pursue deflationary policies. As this materialises, price pressures in the euro zone will ease. Many countries, including France, need to have inflation lower than Germany.
Sometimes economists have expressed the fact that inflation outside of Germany has risen faster than in Germany as those currencies are over-valued cumulative by the inflation (or unit labour costs). Yet no one says that the New Jersey dollar is overvalued relative to the New York dollar. While such an assessment may not be wrong in theory, in practice it leads one to a poor policy prescription. From 2000 through last year, German cumulative inflation (harmonized measure) has been 19.3%. In France 23.2%; in Italy 29% and in Spain almost 35%. In order to regain competitiveness with Germany, those inflation differentials need to be reversed. It would easier to achieve if Germany’s inflation averages more than the 1.6% it has for the past twelve year. The low bar in Germany requires an even lower bar elsewhere and threatens to invoke depression conditions, which in turn spurs political backlash, as we have seen.
To summarize, while an economic official at the BBK did seem to suggest a willingness to tolerate higher inflation, his boss Weidmann denied it. Price pressures in Germany have trended lower over the past six months and are now below the euro zone average. Germany’s solution to the debt crisis and loss of competitiveness is austerity and deflation. With low German inflation, it makes it all the more difficult for others to recoup the competitiveness lost to Germany.
What about Schaeuble’s endorsement of higher wages? Could this change the competitive landscape? Contrary to conventional wisdom, nominal wage growth does not appear to be the key to inflation. German unit labour costs rose by about 2% in Q4 2011, the most recent data.
There have been some encouraging signs. Against the wishes of the beleaguered coalition partner the FDP, Merkel agreed at the end of last year to introduce a minimum wage. She also agreed to a public sector pay increase of 6% that covered nearly 2 years. Telecom workers recently won a 6% pay hike as well. Encouraged by these results and record corporate profits, the largest private sector union, IG Metall, is pushing for a 6.5% wage increase in the current negotiations for its 3.6 mln members. Before the weekend,94k IG Metall workers temporarily slowed down or stopped working in a number of companies to illustrate its seriousness.
The European Summit (heads of state) on May 25 will likely take up the growth pact concept, encouraged by EU Commissioner Rehn and ECB’s Draghi. At the bare minimum it will likely be supported by the European Investment Bank and liberalization of structural funds, whose access currently calls for co-financing, which members have found too onerous and have hence not drawn much on the already allocated funds.
Merkel is nothing if not politically savvy. The political backlash to the Berlin Consensus threatens to topple her next year. She recognises this and is trying to adjust. Yet just as the imbalances and competitiveness divergence took a decade or more to build, they cannot be fixed in a year, even if the will is strong.
Japan has been purposely trying to grow inflation for more than a decade and it has little to show for it. Switzerland and Norway also have been trying to combat deflationary forces with little success. Germany may also find that even if it wanted to, inflation may be more difficult to generate. Nor is it the panacea that some in the press have supposed. Higher German inflation would do little to solve what ails Greece at the moment and would do little to help Spain’s banking system.
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