Inflation nests in 2023: hard to get rid of price increases

DThe good news first: The inflation for February shocked everyone again, but when the first estimate for March comes out in a month’s time, it will inflation rate probably go back. Never before had prices risen as quickly in one month as from February to March 2022, after Vladimir Putin’s invasion of Ukraine. The inflation rate measures the price change twelve months back, and if February 2022 is more than a year ago, then these price increases are no longer there.

But the bad news is: prices are not going down. They just rise more slowly – and not even much. At least five percent inflation is now almost certain for the inflation rate in March. And they’re going to be hard to get rid of in the near future. Why?

Inflation has changed. A year ago, energy prices just went up. For petrol and diesel, for gas, and then also for a few scarce groceries, such as sunflower oil. Inflation has now spread across the economy. Electricity and gas have already come down from their highest prices. Food is now becoming more expensive even faster than energy, and many other things have also become more expensive. Furniture: 10 percent more expensive in January. The car repair: 8 percent. The cleaning help: 12 percent. Restaurants and hotels have increased their prices anyway. Flowers, stationery, the hairdresser: everything is more expensive. And that’s not just because the electricity for the hair dryer now costs more at the hairdresser’s.

Is that already a wage-price spiral?

Wages have already risen sharply in some sectors. Most of the time they didn’t compensate for inflation, but in some federal states there was an increase of more than seven percent in hotels and restaurants, and the building cleaners even got 9.7 percent. Is that already a wage-price spiral in which wage increases continue to heat up prices? At least one can say that last year’s wage increases are now driving prices further. And these days the employees of many other companies are on strike for even higher wage demands.

The employees have strength and assertiveness this time. Staff is scarce everywhere, so it stands to reason that employers don’t look too closely at wages – especially for jobs within Germany that are not in competition with other countries. That won’t change. In the coming years, more and more workers will retire, and the gaps in the labor market will continue to widen.

British central banker doyen Charles Goodhart saw this danger a few years ago. As early as 2020, his book landed on the desks of the most important central bankers with the warning. These central bankers still have a problem now, and it was already unavoidable in 2020. So far, the textbook for central banks in times of inflation provided the following procedure: the central banks raise interest rates, which slows the economy, employees lose bargaining power, wage increases are no longer as high – and inflation can be slowed down again.

“In the past, a weak economy also meant a weak labor market”

But what if there is still a shortage of labor even in a recession, if only because of demographics? And if employers also refrain from layoffs in bad times in order to keep their employees, who they urgently need in the next upswing? It’s just like this: the workers have the power. Interestingly, in the end, this also comes at the expense of themselves in their capacity as customers.

Sylvain Broyer, chief European economist at the rating agency Standard & Poor’s, expects that wages will continue to rise for a long time – so far that the cost of products and services will rise by more than two percent a year, i.e. more than the target figure for Price increases aimed at by the European Central Bank.

“In the past, a weak economy also meant a weak labor market,” says Ulrich Kater, chief economist at Deka-Bank. “There’s not much left of that.” He believes that the labor shortage does not have to drive inflation in the long term. Still, his alternate future isn’t much better. Kater suspects that industries that are in international competition would compensate for the wage increases with cheaper production. In personnel-intensive services, however, this is not possible. In turn, these are often social professions in which the states do not want high wage increases. So there were just a lot of vacancies.

Supply-oriented economic and energy policy

At the University of Frankfurt, the former economy Volker Wieland has another idea: He appeals to the government. You must now pursue a supply-oriented economic and energy policy, i.e. increase the supply of work, goods and energy – because then the inflationary pressure will also decrease. This is not easy to implement either.

And how does all this end in the end? “Central banks need to keep raising rates and then see what’s going on,” respected Chicago economist Raghuram Rajan told the FAS in January. “They will probably go too far and take a long time to revive the economy. But that’s the way the world is.”