MNI INTERVIEW: Prices Key To Puzzle Of Weak German Consumption

MNI (LONDON) - German inflation expectations could become deanchored if the European Central Bank cuts interest rates too quickly, one of Germany’s leading economists told MNI, pointing to the puzzle of higher-than-expected savings ratios which have depressed consumption as a sign that households are not yet convinced prices have been tamed. 

“The German population has a very strong preference for stable prices, therefore there is still a risk inflation expectations could become de-anchored, even though they are now anchored again,” said Oliver Holtemoeller, economics professor at Martin-Luther-University Halle-Wittenberg and vice president of the Halle Institute for Economic Research (IWH).

“Certainly there was a period during the energy crisis where inflation expectations took off a little bit. And this is the danger if the next easing step comes too early and inflation increases again.”

Economists have been “too optimistic” about prospects for a largely consumer-driven German economic recovery, Holtemoeller said, in part because they have been surprised by households’ preference for saving. (See MNI INTERVIEW:Structural Drags On German Growth-ifo's Wohlrabe)

“Real incomes have started to increase again, but the savings ratio is unusually high. Why is not clear,” he said. "Normally one would expect at least the savings ration to go back to normal levels, and that this would imply an increase in consumption expenditure. This is what many institutions in Germany that are involved in forecasting expected, and what we expected when we published our summer forecast back in June.”

One explanation may be that higher interest rates have made leaving money in the bank more attractive, in which case saving rates should track closer to historical means as monetary policy eases, with the ECB expected to cut by another 25 basis points in September.

TIGHT LABOUR MARKET MASKS PROBLEMS

“On the other hand, maybe labour market uncertainty is causing people to save more,” Holtemoeller said, noting that while firms are not laying off workers on a large scale, they are hesitant to hire. While the demand for a 7% pay increase by industrial union IG Metall has grabbed headlines, many public sector workers still face a decline in real net earnings next year, he added. (See MNI INTERVIEW:German Growth Weak Despite Wages- GCEE's Werding)

Overall labour market tightness also masks difficulties many younger people and recent migrants face in entering the workforce, even as those regions most affected by population ageing struggle to fill vacant positions, he said.

Germany’s biggest problem is falling productivity, with the number of hours worked per person declining “quite intensively.” Not only is German GDP growth weak, he said, but it now requires roughly half a million more people to achieve the same level of output as five years ago.

ENERGY PRICES

“Productivity is really at the core of the problem. Nor is it coming from only one sector, it’s a much broader phenomenon. That is one reason why the causes of this strikingly weak development of productivity are so hard to assess.”

Energy-intensive industries such as car makers and chemical companies have in many respects adjusted to higher energy prices, but their production levels are not recovering, Holtemoeller said.

“This will probably stay with us as long as energy prices in Germany are higher than in other countries, which is for the foreseeable future.”

Given supply-side constraints, monetary policy can do little to boost growth, and it will be up to the government in Berlin - currently locked in renegotiations over its 2025 budget - to come up with polices to get the economy moving again, he said.

“The government simply has to agree on something. It's almost less important what that is than it is to settle a path and make it more projectable, so that firms and decision-makers can plan. At the moment they don't know what the government is going to decide from month to month.”