Price shock jeopardises recovery of German economy

Russia’s war in Ukraine is hitting the German economy primarily via an energy price shock, but also by disrupting trade flows and causing general uncertainty. At the same time, however, the economy is receiving a strong boost from the lifting of many pandemic restrictions. The Halle Institute for Economic Research (IWH) forecasts that gross domestic product will increase by 3.1% in 2022. The consumer price index will be 4.8% higher than one year ago. The war affects the East German eco-nomy about as hard as the economy in Germany as a whole.

Authors Oliver Holtemöller

Russia’s attack on Ukraine has drastically worsened economic conditions in Europe. Prices for raw materials and energy, and here especially for natural gas, have risen sharply, the sanctions are bringing trade with Russia that goes beyond energy supplies to a virtual standstill, and European share prices have fallen significantly in value. In the event of a halt to Russian supplies, gas would have to be rationed in Germany, and a sharp recession, especially in the manufacturing sector, was to be expected. If, as assumed here, the gas flow continues, the main economic effect of the crisis will be the rise in energy prices, leading to real income losses for private households and a loss of competitiveness for firms, especially because natural gas is particularly expensive in Europe. Value chains that led through Ukraine or Russia are also being torn apart. Inflationary pressures, which were already high in most regions of the world before the start of the war, will intensify further. In the US, monetary policy is turning less expansive which entails the risk of an economic downturn in the country itself, but also worldwide.

The war is hitting the German economy in a recovery phase, after the winter wave of the pandemic caused private consumption and economic activity to decline in the final quarter of 2021. “The pandemic is by no means over, but with the lifting of many restrictions imposed to combat the pandemic in March, the recovery is likely to gain momentum,” says Oliver Holtemöller, head of the Department Macroeconomics and vice president at the IWH. This is because private households are likely to spend some of the savings they accumulated during the pandemic in the coming quarters, which will benefit service providers in particular. Production is therefore likely to expand quite strongly in the second quarter. However, consumers will have to use part of the money to meet the higher cost of living, as the Russian war will further increase the already strong price momentum in Germany. “Inflation, shortfalls in exports to Eastern Europe, and general uncertainty are channels through which the war is dampening the German economy, and consequently, rates of output growth will go down significantly in the second half of the year,” Holtemöller says. The build-up in employment slows in the course of 2022, coming to a virtual standstill towards the end of the year due to the sharp increase in the minimum wage. High energy and raw material prices cause the German current account balance to fall sharply from 6.9% as a share of GDP in 2021 to 5.4% in 2022. The budget deficit is expected to decline significantly in the current year, as social security revenues are expected to expand at an accelerated pace as the economy picks up, while public spending is unlikely to rise much because the costs of the Corona pandemic will be declining.

The extended version of the forecast (Konjunktur aktuell: Konjunktur aktuell: Price shock jeopardises recovery of German economy) contains the following four boxes (all in German):

Box 1: The Russian economy is structurally weak

Box 2: Assumptions for the forecast

Box 3: Estimation of potential output

Box 4: Forecasting greenhouse gas emissions

Publication: Drygalla, Andrej; Exß, Franziska; Heinisch, Katja; Holtemöller, Oliver; Kämpfe, Martina; Kozyrev, Boris; Lindner, Axel; Müller, Isabella; Sardone, Alessandro; Schultz, Birgit; Staffa, Ruben; Zeddies, Götz: Preisschock gefährdet Erholung der deutschen Wirtschaft. IWH, Konjunktur aktuell, Jg. 10 (1), 2022. Halle (Saale) 2021.

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