Inflation: why prices could rise in Europe just as they do in the US

Berlin, Brussels In the USA, the concerns seem to be confirmed: prices soared by 6.2 percent in October, the highest increase in 30 years. US President Joe Biden comes under increasing pressure. “It is a top priority for me to reverse this trend,” he promised on Wednesday.

Nevertheless, the EU Commission gives the all-clear, at least for the time being. The Brussels experts do not currently see American inflation conditions in Europe. Inflation will peak this year and then gradually level off again, said EU currency commissioner Paolo Gentiloni on Thursday when presenting the autumn forecast for the European economy.

On average for the year, the Commission expects an inflation rate of 2.4 percent in the euro area. In 2022 she expects a slight decrease to 2.2 percent. In 2023, inflation will again be 1.4 percent below the European Central Bank’s (ECB) target of two percent.

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In fact, almost all economists agree that the current inflation is based primarily on temporary effects, such as high gas prices, bottlenecks in key sectors such as the chip industry and disrupted international supply chains.

High property prices under the radar

But now the question arises whether the temporary effects will result in permanent development. “There are many good reasons for long-term inflationary pressure in Europe,” says Gunther Schnabl, head of the Institute for Economic Policy in Leipzig.

This can also be seen in the comparison with the USA. There are structural differences to the EU, which are also reflected in the price development. But there are some indications that the rising prices in the USA will also show up in Europe. A comparison of business cycles shows that Europe is a few months behind the US.

There is also a methodological difference that automatically leads to a lower inflation rate in the EU. In the USA, high real estate prices have an impact on inflation because the prices for owner-occupied residential property are included in the consumer price index. “Up to half a percentage point of inflation should make up for that,” says Carsten Brzeski, chief economist at ING-Bank.

In the future, owner-occupied real estate should also be taken into account in Europe, but the forecasts such as the current one by the EU Commission do not reflect this. The price index for owner-occupied residential property rose in the second quarter by around two percent to a record level since the start of the data series 21 years ago.

What has so far differentiated the situation in Europe from the United States has been the fiscal policy impetus. US President Biden has spent a lot of money to stimulate the economy – and thereby fueled consumption by Americans in particular. The EU states have so far been more cautious in this regard; they tend to focus on investment programs that are assigned a lower inflationary effect.

Economists like Schnabl fear, however, that the Europeans could take the US’s lax spending policy as a model. The reform of the EU Stability Pact, which many member states are striving for, could ensure that consumption in Europe is even more fueled by the states. However, this argument is still speculative. The debate about adapting the debt rules has just begun, and the Commission does not intend to present a proposal until next year.

Response from monetary politicians required

One important factor is inflation expectations. If the concern about price increases is decoupled from the actual inflation event, it can become self-fulfilling and drive inflation. “This danger exists in the USA and in the euro area. To prevent such a decoupling, you need a well communicated normalization strategy, ”says Brzeski.

While the US Federal Reserve has initiated precisely this exit from its loose monetary policy and wants to scale down its bond purchases first, the ECB continues to insist on its expansionary course.

This could fuel expectations of further increases in prices among the population. Brzeski expects the ECB to follow suit in December. Council member Robert Holzmann took a first step on Thursday when he announced the end of bond purchases in September 2022.

So risks remain, Gentiloni also admitted this and emphasized that the Commission would “keep a close eye on the development of prices”. Overall, however, he painted a positive picture of the economic situation. So far, there are no signs of a wage-price spiral in which more inflation leads to rising wages, which in turn lead to even more inflation.

In the Commission’s view, however, the data show that the economy is getting better and better. Gentiloni said the EU will regain its pre-crisis level of economic power more quickly than expected. This year, growth in the EU will amount to five percent, in the coming year it will be 4.3 percent. The EU expects the same values ​​for the euro area.

However, there are clear differences between the Member States. Germany, which has long been the growth engine of the continent, is falling more and more behind its neighbors. While the French economy grew by 6.5 percent and the Italian economy by almost 6.2 percent this year, the growth expected for the Federal Republic is just 2.7 percent.

The Commission cites supply bottlenecks and production problems as reasons, which would have hit Germany particularly hard. In addition, Germany suffered less from the crisis and now has less growth to catch up with. In 2021, the German economy would pick up again. Whether this will be the case depends in particular on the development of inflation.

More: OECD chief economist warns of “highly uncertain phase” in inflation

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