The Recent Slowdown of Inflation in Germany

Today I want to take a look at two common measures of inflation, namely (1) the Consumer Price Index (CPI) and (2) the GDP deflator for Germany from 1991 to 2015. For this I obtained the indicators from the World Development Indicators database (World Bank, 2016). The database contains the CPI and the GDP deflator as well as the corresponding inflation rates.

germany inflation 1
(Source: World Bank, 2016)

Let’s take a look at CPI inflation in Germany first. Inflation came down from 5.08 percent in 1992 to 0.23 percent in 2015. After 1994, the country experienced CPI inflation below the 2 percent level except from 2007/08 (still below 3 percent) and 2011/12 (little above 2 percent). Overall, many of the fluctuations in Germany’s CPI can be attributed at least partly to changes in the price of oil. In particular, the spike in inflation in 2008 was triggered by the oil price shock, resulting in rising transport and heating costs, as well as by the 2007-08 world food price crisis. The temporary drop to 0.31 percent CPI inflation per annum thereafter derived from rapidly falling oil and commodity prices. This was because the global recession led to a negative demand shock in 2009 after the initial negative supply shock in 2008. Also the second spike after the recession in 2011/12 can be attributed to the recovery of oil prices and their subsequent fall to extremely low levels in 2014 and 2015 compared to the 2000s.

In comparison, inflation measured by the GDP deflator has somewhat diverged from CPI inflation after 1995. It fell rapidly most of the time from 1992 to 2000 to -0.45 percent and it was highest in 2013 at 2.09 percent. In most years since 1995 it has been below CPI inflation except from 2003, 2009 and 2013. The difference between the two measures was greatest in 2000 at 1.9 percentage points followed by 2008 with 1.8 percentage points and 1997 with 1.6 percentage points. As the GDP deflator only includes domestic produce, it underestimates inflation in case of imported inflation such as through oil imports, which is what seemed to have happened in 2008 or 2011/12, for example.

germany inflation 2
(Source: World Bank, 2016)

But how did Germany perform overall over the period? Germany has an inflation target close to 2 percent in line with the Eurozone and the ECB. The diagram above shows that after the slowdown of inflation in the 1990s, Germany came close to its inflation target from 2003 to 2008. After 2008, however, inflation took a further hit and reduced to an average of 1.26 percent per annum over 2009 to 2014, not to mention the recent fears of deflation. This slowdown in inflation is of concern as interest rates – as the main tool to control inflation – are already low, almost tying the hands of monetary policy (liquidity trap). It can be said that Germany is currently performing better than its European peers in terms of unemployment and recovery from the GFC with a strong manufacturing sector which has shifted its focus to faster growing eastern markets (Speciale, 2015). However, somewhat higher inflation could support GDP growth and the restrengthening of the economy. Conversely, if low inflation was to become persistent, it could induce consumers to delay spending as things get cheaper over time or companies to hoard cash rather than invest. A slide into deflation would increase debt servicing costs, i.e. the debt burden, which would pose a drag on government finances and economic growth.

In summary, Germany did ‘tame’ inflation, but after 2008 the success reversed from too high inflation to too low inflation. Low inflation has played a key part in the sluggish recovery, even if Germany is currently outperforming its European peers.

Thanks for reading!

Jasse


Speciale, A. (2016, 7 January). Germany Tracking Shift in Global Growth Drives Europe’s Recovery [online]. Bloomberg. Retrieved from: http://www.bloomberg.com/news/articles/2016-01-06/germany-tracking-shift-in-global-growth-drives-europe-s-recovery

World Bank (2016). World Development Indicators: Germany [Data file]. Retrieved from: http://data.worldbank.org/country/germany

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