“Inflationary pressure will remain very high until the end of the year. The current double-digit inflation rate of wholesale prices shows that price dynamics are fuelled by global supply shortages. But prices are also rising across all service providers. Even though the rate has already exceeded four per cent, we should not yet begin to dramatize this development. The price surge reflects, first of all, the encouragingly strong and sweeping recovery of the domestic and global economy after the deep dive witnessed in the pandemic. The real test will come from January onwards when the one-off effects from last year’s VAT cut expire. It is safe to say that inflation will then fall again from its current level. However, it is completely uncertain how quickly it will return to a moderate level of around two per cent. This is a question that remains open for 2022.”
The Federal Statistical Office published its preliminary results on the development of the German inflation rate in July. According to the calculations, the inflation rate measured by the German consumer price index has risen to 3.8 per cent, a significant increase compared to 2.3 per cent reported in June. Professor Friedrich Heinemann, head of the Research Department “Corporate Taxation and Public Finance” at ZEW Mannheim, comments on this matter.
“The expected sharp increase in inflation has now started. In the next few months, Germany is likely to experience the strongest inflation spike in three decades. Current inflation comes as a consequence of the pandemic and its perturbing effects on the global markets. After demand has been pent up for many months, it is currently meeting a still limited global supply of goods. High pandemic-related costs for service providers and the long-term effects of last year’s temporary VAT cut in Germany are further factors contributing to higher inflation. Although several of these factors are only temporary, the consequences and risks of sharp rise in inflation must not be underestimated.
Assets that yield little or no interest are currently being devalued. The initially only temporarily increased inflation bears the risk of resulting in a wage-price spiral. Though the ECB cannot be blamed for this current price jump, it is now responsible for ensuring that the temporary increase in inflation does not become permanent. However, there are also beneficiaries of rising prices, with the government among the biggest winners. As inflation is currently higher than interest rates on government bonds, the government can effectively reduce its debt burden. Inflation also allows the treasury to count on substantial additional tax revenues, especially from progressive income tax. For German taxpayers, higher inflation will result in a considerable tax increase through the backdoor due to the bracket creep effect.”
The Federal Statistical Office published its preliminary results on the development of the German inflation rate in June. According to the calculations, the inflation rate measured by the German consumer price index reached 2.3 per cent, decreasing only slightly compared to May. Professor Friedrich Heinemann, head of the Research Department “Corporate Taxation and Public Finance” at ZEW Mannheim, comments on this matter.
“The view that current inflation is driven by short-term factors is on the one hand correct, but only part of the truth. It is true that an exceptionally sharp rise in import prices and the extraordinary circumstances of the pandemic are pushing inflation up. Yet it is by no means certain that this short-term inflation will disappear as quickly as it came. There are three factors that indicate that there is a risk of a permanent rise in inflation. First, the increase in import prices is not necessarily temporary, as labour costs in China and other emerging markets are rising sharply and steadily. Second, the significant loss of purchasing power that workers in Germany suffer from this inflation is likely to have consequences for the next wage negotiations and increase wage pressure. And thirdly, confidence is dwindling that the European Central Bank will resolutely combat a sustained inflation dynamic. The highly indebted euro states have become too dependent on bond purchases and zero interest rates. There is much to suggest that we should prepare for a longer farewell to the era of very low inflation rates.”