AUS DEM SPIEGEL
Ausgabe 27/2008

A Dangerous Cocktail Europe Grapples with Threat of Stagflation

As rising energy and food prices continue to fuel inflation, the economies in industrialized countries are beginning to stagnate. The mix, known as stagflation, presents politicians and central bankers with virtually insurmountable problems.

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The European Central Bank is meeting Thursday. It is expected to raise interest rates to try to deal with inflation.
AP

The European Central Bank is meeting Thursday. It is expected to raise interest rates to try to deal with inflation.

A leading politician sometimes encounters real life on the premises of his own ministry. One such place is the grand chamber of Germany's Finance Ministry. That was where Finance Minister Peer Steinbrück, a member of the center-left Social Democratic Party (SPD), had summoned his workforce to a general meeting the Friday before last. The minister expected his staff to arrive in good spirits, especially since this year Germany's public sector employees are getting their first perceptible pay increase in a long time.

But the civil servants Steinbrück encountered seemed less than enthusiastic, bluntly informing their minister that while they may be getting a raise, the rising cost of fuel and food is eating up most if not all of their additional income. "Inflation is really getting to my people," Steinbrück concluded. They aren't the only ones. Workers everywhere are complaining that they are deriving little or no benefit from pay increases. Although wages and salaries increased by 2.8 percent in the first quarter in Germany, prices rose even faster, by close to 3 percent, reflecting a tendency that has been in place for some time. In the eurozone as a whole inflation hit a record 4 percent in June.

Money is worth less and less, but not just in Germany and Europe. Prices are rising, in some cases skyrocketing, worldwide. Statisticians in the United States report inflation in excess of 4 percent, while consumers in emerging nations are even worse off. Some countries are seeing double-digit inflation, including 11 percent in India and 14 percent in Russia.

There is no doubt about it: After decades of calm on the price front, a time in which monetary stability seemed assured, inflation has returned as a global problem. "An Old Enemy Rears Its Head," Britain's Economist concludes.

For years, globalization kept worldwide prices in check. With their inexpensive goods, countries like China and India made sure that people in the developed, industrialized nations could buy more for their money. Besides, competition from within Asia kept domestic producers from raising prices for their products.

But now the beneficial effect of globalization is being reversed. Emerging nations, instead of bringing down prices, are suddenly driving them up. To keep their economies booming, they need more and more energy. As a result, they compete for oil and gas worldwide, constantly driving prices to new highs.

The developing countries' thirst for resources also makes life more expensive in the West. In Germany, the price of gasoline has been at €1.50 a liter (roughly $8.80 a gallon) for weeks, and natural gas is expected to be at least 20 percent more expensive this year. Politicians are alarmed. "The new surge of inflation could cause political unrest worldwide," says German Finance Minister Steinbrück.

To make matters worse, growth threatens to stagnate in the established industrialized countries. The economy in the United States is hardly growing at all anymore, while the European economy has cooled noticeably. The Ifo Institute, one of Germany's leading economic research organizations, predicts growth of only 1 percent in Germany for next year.

The word "stagflation" -- that dangerous cocktail of economic stagnation and rising inflation -- is making the rounds once again. The last time this phenomenon occurred in the United States and Western Europe was at least 30 years ago. At the time, central banks only managed to restore monetary stability by imposing drastic monetary measures -- at the price of a deep recession, costing millions their jobs.

Is it time for the world to prepare for a comparable situation? The parallels cannot be overlooked. Uncertainty over further developments is spreading, as a sense of nervousness grows. Markets worldwide plunged last week.

With elections on the horizon this year in Germany, politicians will contend with a dangerous mix of rising prices and newly growing unemployment. The political class in Berlin, headed by Chancellor Angela Merkel, leader of the conservative Christian Democrats (CDU), is wholly unprepared for the new realities. Instead, it is still squabbling over how best to distribute the fruits of an economic boom.

Instead of talking about issues like increasing tax revenues, lowering unemployment, balancing the budget, the minimum wage and increasing federal childcare subsidies, politicians could soon see their agendas dominated by completely different topics and problems they had believed were long since overcome: longer lines in the hallways of employment agencies, corporate bankruptcies, budget shortfalls and cuts in social spending.

Rising Prices and Curbed Growth.
DER SPIEGEL

Rising Prices and Curbed Growth.

In addition to economic risks, the scenario is rife with political uncertainty. How will the electorate react when the economy tips and prices explode? What happens when more and more citizens will have to do without a car or their customary vacations, or when many are forced to go into debt to pay for the drastic spike in home heating costs?

Those in power sense the potential impact that the accumulated wrath of voters would have on politicians in Germany's ruling coalition parties, the CDU and SPD. Voters would punish politicians for rising unemployment figures and the government's failure to live up to its promise to balance the national budget within a few years.

Some politicians would benefit, namely those who claim that the crisis can be confronted with simple formulas, like higher wages and pensions, as well as lower energy prices for low-wage earners. If a party like the Left Party can garner double-digit approval ratings in all opinion polls in relatively good times, how much more popular will it become when times get worse?

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