Joachim Nagel: The current economic situation
Welcome words by Dr Joachim Nagel, President of the Deutsche Bundesbank, at a
Club evening of the International Club of Frankfurt Economic Journalists, Frankfurt am
Main, 21 November 2022.
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1 Words of welcome
Ms Schreiber,
Many thanks for your kind invitation and warm introduction.
I am very pleased to join the ranks of the Bundesbank presidents who, starting when
the euro was introduced back in 1998, have been invited by the International Club of
Frankfurt Economic Journalists to meet with its members for an exchange of views and
ideas. Like my three predecessors, Ernst Welteke, Axel Weber and Jens Weidmann, it
is very important to me to communicate and interact with media representatives.
In times of high inflation, it is all the more necessary to explain and contextualise what
pushes inflation higher and how effective monetary policy measures are. As journalists,
you have a particularly important role to play here as the link between an institution
such as the Bundesbank and the general public. That's because, in turn,
communication with the public is key to the effectiveness of monetary policy and of
economic policy in general.
A current example is the proposal put forward by the gas price commission. Unlike a
price cap, the gas price brake does not distort price signals at all. However, for the full
effect of the gas-saving incentives contained in this brake to be felt, the general public
needs to correctly understand them.
Communicating in an accessible way with the outside world helps to create trust - and
trust is an indispensable foundation for monetary policy. Christine Lagarde summed it
up well recently.: "If people don't understand what I'm saying, how can they trust me?
After all, today people don't trust someone only because the person expresses herself
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or himself in a complicated way "
Your reporting makes a significant contribution to helping us achieve our monetary
policy objectives. The way in which you explain and give context to this complicated
subject matter helps your audience understand it. But we central bankers and
economists also need to take care to express ourselves in a way that can be clearly
understood. Accessible communication fosters public trust - and that is what the
success of our monetary policy measures hinges on.
It is precisely this confidence in our ability and our determination to ensure price stability
that will be vital in the coming months - because challenging times lie ahead. And the
ECB Governing Council will have to continue to adopt measures that are unlikely to be
to everyone's taste.
I'll come to that later. First of all, let's look at the state of the German economy.
2 Economics activity and prices
Up until the third quarter of this year, Germany's economy was still on the right track.
Economic output was back at pre-coronavirus levels in the second quarter. And in the
third quarter, catch-up effects in connection with the pandemic and a large order
backlog combined with easing supply chain pressures gave the economy a boost.
But Russia's war against Ukraine, energy supply uncertainty and high energy costs are
increasingly weighing on households and enterprises. Retail trade has already suffered
decreases in real sales. Activity in the construction sector has slowed down.
And industry, in particular, has used less gas in view of the high prices:
energyintensive industrial sectors have cut back their production. In this respect, the price
mechanism has a similar effect to a rationing of gas: production declines.
Despite these headwinds, gross domestic product still posted a slight increase in the
third quarter, climbing by 0.3% on the quarter. However, pervasive uncertainty is
eroding sentiment at enterprises across all sectors and among consumers on a
considerable scale. Although the GfK consumer climate index forecast for November
was back up again slightly, that still leaves it only just above its record low.
Gas storage facilities are currently almost completely full. But that shouldn't lull us into a
false sense of security. The supply situation could become tight, depending on how the
weather and consumption patterns play out. That's why the gas-saving incentives
contained in the gas price commission's proposal are so important.
At present, our Bundesbank experts do not expect outright rationing this winter. But gas
and electricity prices could rise again. The high energy costs could lead to a decline in
industrial production, in particular, especially in energy-intensive sectors such as the
chemicals industry. The recent downbeat production plans and export expectations in
industry are consistent with that view.
Households, too, are likely to lean towards tightening their purse strings in the coming
months. Considerable losses in purchasing power and concerns about high gas bills
have cast a further shadow over their propensity to spend. All in all, economic output
could fall significantly and across the board in the fourth quarter of 2022 and first
quarter of 2023. If this were to happen, we would be faced with a recession.
Its scale would depend on many uncertain factors. These include households' gas
consumption, temperatures and the effect of policy measures. One thing is for sure: gas
shortages would amplify downward forces.
The European Commission is expecting the German economy to shrink next year, with
a decline of 0.6% anticipated by experts. Projecting growth of -0.2%, the German
Council of Experts is somewhat more optimistic.
The inflation rate in Germany is far too high. It rose further in October to reach 11.6%,
hitting its highest level in more than 70 years. Inflation as measured by the HICP is
expected to be above 8.5% in 2022.
This is largely due to the Russian war of aggression against Ukraine and its
consequences. However, inflation was already on a strong upward trajectory even
before the war broke out, what with the global economy recovering unexpectedly
quickly from the coronavirus crisis. Supply wasn't always able to keep up, and supply
chains were disrupted.
Inflation in Germany will probably remain high next year, too. I believe it is likely that, on
an annual average, we'll see a seven before the decimal point. And the risks are clearly
tilted to the upside given the tensions in energy markets.
As for the euro area, the impact of the energy crisis will likely be less pronounced than it
will be on Germany. Which is why the European Commission is expecting economic
output in the euro area to still increase slightly in 2023, in contrast to Germany.
Economic activity in the euro area, too, is being hampered not only by tensions in the
energy market but also by high inflation. The substantial upward pressure on prices is
broad-based. It is dragging on private consumption, in particular. This year, consumer
prices in the euro area have risen time and again at rates not seen since the
introduction of the euro. At 10.6%, the October rate was the sixth all-time high in a row.
Core inflation stood at 5.0% in the same month.
And for the next two years, the inflation forecast last published by the European
Commission provides figures that are noticeably above our medium-term inflation target
of 2%, namely 6.1% for 2023 and 2.6% for 2024. However, the forecasts should be
interpreted with caution, as the outlook is highly uncertain at present. Price dynamics
have been underestimated in all Eurosystem projections since mid-2020.
And upside risks clearly predominate at the moment. First, tensions in energy markets
could persist for longer than assumed in the forecasts. Second, the still high commodity
prices could be passed on to consumers to a greater extent than is usually the case.
And third, wages could rise more strongly than expected, partly in response to inflation
surprises.
3 Monetary policy
In view of these price developments and the outlook for inflation, the ECB Governing
Council is acting decisively. We have taken the first steps towards normalising
monetary policy. In our July meeting, we set the interest rate reversal in motion. We
raised key interest rates by 0.5 percentage point and brought the chapter of negative
deposit rates to a close. In September and October, we followed this up with larger
interest rate hikes of 0.75 percentage point each. And in December, we will certainly be
following up with a further interest rate increase to bring the inflation rate back to 2% in
the medium term.
The size of each interest rate step and how high we will raise the rates will depend on
how the data and outlook develop. As things currently stand, I still believe that decisive
action is warranted - without wishing to call for an interest rate step of any particular
size.
However, monetary policy normalisation is about more than just raising key interest
rates. At its next meeting, the Governing Council will also discuss the ECB's large bond
holdings. In my view, there is much to be said for no longer replacing all maturing
bonds, starting next year. This would underscore our commitment to ensuring that
inflation returns to the medium-term target of 2% in a timely manner. It would also send
out another clear message from the Governing Council about combating inflation.
However, the Governing Council is sometimes accused of raising interest rates
irrespective of economic developments and thus exacerbating the economic weakness
in the euro area. On this question, we need to bear in mind why we are experiencing a
slowdown in economic activity: the culprits are the supply bottlenecks caused by the
pandemic and the war.
The ifo Institute illustrated this well: the Munich experts expect the German economy to
suffer drastic real income losses as a result of rising gas and oil prices. They put these
losses at a total of €64 billion for this year alone, which corresponds to just under 2% of
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GDP In other words, flagging economic activity is mainly being driven by external
influences.
Our forceful monetary policy measures are designed to ensure that high inflation does
not become entrenched. And that is necessary. If we act too hesitantly, we run the risk
of having to tighten monetary policy much more severely further down the road. And
that would place an even greater strain on economic activity and the financial system.
This would happen, for example, if inflation expectations became unanchored and a
price-wage spiral emerged. It would be wrong, then, to act too hesitantly for fear of a
downturn.
Naturally, we are monitoring economic developments very closely. And yes, if output
grows more slowly or even shrinks owing to weaker aggregate demand, inflationary
pressures will wane. But as far as we can currently tell, this effect alone will not be
enough to put inflation back on track.
4 Conclusion
As you can see, we are currently facing major challenges. If we are to master these
challenges, we will need good economic and monetary policy, accompanied by clear
and coherent communication. For this to succeed, I now look forward to answering your
questions.
Thank you very much for your attention.
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Lagarde, C., Die Stunde der Eule, Der Spiegel, 5 November 2022
ifo Institute, Zur Bestimmung der Realeinkommensverluste in der gegenwärtigen
Energiekrise, ifo Schnelldienst, 2022, 75, No 11, 47-53, Munich.