High costs presently dictate people's daily lives. Why an austerity program and the European Central Bank's interest rate rise are the incorrect way to proceed.

Rising prices in Europe: Inflation cannot be saved away
[Europe energy crisis 2022]

The cost of activities that are part of daily living, such as shopping, filling up, and bathing, has increased. The rate of inflation in the euro zone is relentlessly climbing higher. Surveys indicate that for a long time, the majority of people have viewed price inflation to be their primary worry. People living in poverty have a difficult time making ends meet. That amounts to about 14 million individuals in the country of Germany. The upshot of this is that at the end of the month, refrigerators are left empty and there are enormous lines at food banks. And even those who make an average income now have to be conscious of their financial situation and make sacrifices, such as preparing their own meals at home rather than going out to eat, using margarine rather than butter, watching Netflix rather than going to the movies, or vacationing in the Baltic Sea rather than Tenerife. The vast majority of Germans have some money put away for future use. The Minister of Federal Finances, Christian Lindner, is considering doing the same thing in the near future. After a period of three years, it must at long last be reset to the debt brake. Lindner insists that there should be no more "politics on credit." A good idea?

You would need to investigate the specific causes of the increased cost as well as the reasons why. The Federal Statistical Office provides a month-by-month breakdown, item by item, of which prices are increasing and by what amount. The annual percentage rate of inflation was little lower than eight percent in June. That the costs of living an ordinary life are now eight percent more than they were a year ago. Energy is without a doubt the factor that has the most impact on prices. Since the beginning of this year, the prices of gasoline, diesel, heating oil, natural gas, and electricity have all increased by an average of 38 percent. This also has an effect on things like groceries, the manufacturing of which, transportation of which, and display of which in the refrigerated section all demand a significant amount of energy. As a result, the typical cost of food has increased by roughly 13 percentage points over the last year. Services, on the other hand, have only increased in price by two percent over this time period, such as scheduling an appointment with a hairdresser or going to the movies.

The conflict in Ukraine is the primary contributor to the rise in the cost of energy. As a result of the conflict, prices for oil, gas, and coal have increased since these resources are becoming more insecure and scarce. All of these fuels have been purchased from Russia by Germany up to this point. The Federal Republic of Germany is highly reliant on Russia, particularly for the provision of gas. Energy has always been subject to the whims of an ongoing economic conflict. While the European Union has chosen to stop using coal and oil, Putin is tinkering with the gas tap. Prices on the European stock market are several times higher than they were a year ago as a direct result of the unpredictability around an imminent gas shortage. Since the German gas provider Uniper, for example, receives less gas from Putin at a reduced cost, it is forced to purchase gas on the market at costs that are much higher. A multi-billion dollar loss for Uniper's company due to the fact that the corporation is still obligated to provide its clients at the contract rates.

The present predicament cannot be adequately described using the word "inflation." In reality, it is a description of a dynamic that reinforces itself and leads to an increase in practically all prices. This dynamic is often referred to as the wage-price spiral. A well-known illustration of this phenomenon is when labor unions successfully lobby for pay hikes, which in turn raises operating expenses for businesses, which subsequently raises prices in order to recoup some of the losses and then the cycle begins again. However, since wages have rarely grown since the epidemic, this spiral does not seem to be occurring at the present time. Even the head of the company, Rainer Dulger, acknowledges that fact.

It is also not true that businesses are increasing their pricing due to the fact that consumers are spending more money and the economy is thriving. After two years of the epidemic, an already shaky economy is about to face the next recession. The level of consumer confidence reached an all-time low in June, and business in the retail sector is struggling. People are able to reduce their spending on other necessities such as food, furniture, and clothes due to the increased cost of electricity. Still far below their pre-corona levels, private purchases and investments are on par with 2017's output levels in the industrial sector. Because there was neither a boom nor a wage-price spiral, the one-time shock in energy prices continues to be the primary explanation; this is a significant change.

Now, let's get back to the original question: is it a smart move for the minister of finance to desire to save money? If people saved, it would be beneficial at times when the economy was too hot. Or even if we assumed a standard rate of inflation. But not with such a massive jolt of energy as the one that we are presently feeling. In point of fact, however, the reverse is true: taking on debt might actually result in reduced pricing. There are two different approaches to take here. To begin, the state has the ability to combat excessive costs on its own by lowering taxes, providing grants, or providing subsidies for essential gas supplies, for instance. In June, for instance, the inflation rate was brought down thanks to the discount on petrol and the nine-euro ticket. People have been able to breathe a little easier since July since they are no longer required to pay the EEG fee. This brings down the overall cost of living. The elimination of value-added tax on essential groceries would be a significant factor in lowering grocery store pricing.

Second, the state may take measures to make it easier for us to get energy at lower costs or to make better use of it. For instance, by increasing production of wind and solar energy, by renovating buildings with a focus on energy efficiency and bringing heating systems up to date, or by increasing the number of bus lines and train lines in order to reduce the number of commuters who rely on their personal automobiles. Both providing aid and making investments need financial resources. Because the Minister of Finance Lindner would have to be ready to take on new loans in order to pay for any one of these items, he would have to abandon his efforts to save money. The timing for the reintroduction of the debt brake is thus not appropriate.

In hindsight, it is possible to make the argument that if the state had taken on additional debt over the course of the previous ten years in order to invest more money in the transition of the energy system and the transportation system, then we would not be as reliant on the expensive oil and gas imports from other countries today. If this were to occur, the rate of inflation would fall, making people's day-to-day lives more inexpensive. If people put money aside, the government shouldn't match that amount since it would make the economic downturn worse and wouldn't do anything to combat rising costs. On the other hand, the traffic light should be able to construct a path toward a secure future by making astute investments and obtaining a third relief package.

Additionally, businesses are in need of this bridge. They would also need to make investments in order to build up additional capacity, transition from gas to other energy sources, or become more energy efficient. All of these things would need investments. However, if individuals and the government both conserve money, this results in a loss of income for the economy, which in turn slows down economic growth. When the economy is in a tailspin, many businesses choose not to invest. It is not worth taking such a substantial risk that one's efforts in revitalization and sustainability would not bear fruit. When this occurs, investments are delayed and the funds are saved instead.

Because of this, the recent decision made by the European Central Bank to increase interest rates was a poor one. When interest rates are higher, it is both more costly to borrow money and more difficult to make investments. This, in turn, has the effect of slowing down the economy and putting more people out of job. As a result, they are not an appropriate solution to the problem of excessive energy costs. Because the demand for energy sources such as gasoline, electricity, and gas is barely influenced by interest rates. Before turning down the thermostat, turning off the shower, turning off the stove, or reducing production, businesses and individuals should first look at other ways to save costs. If the interest hammer is effective, then the only conclusion that can be drawn is that the procedure was successful but the patient did not survive. It is really unfortunate that the current political trajectory is geared to contract rather than expand; doing so would be a grave error.

The author Maurice Höfgen is an economist, business economist and writer based in Berlin, Germany.
Source: IPG
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