Economic downturn: It's not just inflation and higher interest rates that weigh on the German economy

Highlights: Germany is the only G7 industrialized country whose economy is shrinking this year. Consumer prices in September were 4.5 percent higher than in the same month last year – after 6.1 percent in August. The export-oriented German economy is feeling the effects of the crisis in the global economy. Despite the weak economic development, Germany is still seen internationally as a pillar of the financial system, according to Finance Minister Christian Lindner. "We are something like an anchor of stability, because our debt is going down, the debt ratio is falling," the FDP politician said.

The German economy does not currently make a good impression by international standards. Is Germany once again the "sick man of Europe", as the British magazine "The Economist" recently headlined?

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Shopping street in Munich: Consumption restricted

Photo: Wolfgang Maria Weber / IMAGO

The German economy is weakening. According to the International Monetary Fund, Germany is the only G7 industrialized country whose economy is shrinking this year. The Federal Statistical Office will publish preliminary figures on gross domestic product in the third quarter on Monday morning. Answers to the most important questions in advance:

Why is inflation dampening economic development?

Significantly higher prices are a burden for consumers. They can afford less for their money. In a recently published survey commissioned by the German Savings Banks and Giro Association, 61 percent of a total of more than 4800,<> respondents said in the summer that they had reduced their consumption in the past twelve months. Private consumption is an important pillar of the economy. "Above all, the high prices for food are weakening the purchasing power of private households in Germany and ensuring that private consumption will not be a pillar of the economy this year," expects Rolf Bürkl of the Nuremberg-based market researcher GfK.

How has inflation evolved?

Inflation remains a burden despite a significant decline in Germany. Consumer prices in September were 4.5 percent higher than in the same month last year – after 6.1 percent in August. Germany was heavily dependent on cheap Russian gas before the start of the Ukraine war in February 2022. When Russia cut off supplies, energy prices skyrocketed, pushing inflation overall. In the meantime, food prices in particular are weighing on consumers.

What role do ECB interest rate hikes play?

In the fight against inflation, the European Central Bank has raised interest rates ten times in a row since July 2022. Recently, in view of lower inflation rates, the euro currency guardians did not turn the interest rate screw any further. Higher interest rates make loans more expensive, which can curb demand and counteract high inflation rates. At the same time, more expensive loans are a burden on the economy because credit-financed investments become more expensive. This is one of the reasons why private house builders and large investors are holding back on construction projects.

What else is weighing on the German economy?

The export-oriented German economy is feeling the effects of the crisis in the global economy. "Weaker foreign trade hits the German economy beyond measure and more than some other nations," said Economics Minister Robert Habeck recently. The global economy is only slowly recovering from the consequences of the pandemic, Russia's war against Ukraine and inflation – growth is historically weak, according to the IMF. "The global economy is limping along, it's not sprinting," IMF Chief Economist Pierre-Olivier Gourinchas said recently.

What supports the German economy?

The labour market is proving to be robust. According to the Federal Employment Agency, the demand for workers remains high. There is a shortage of staff in many places. Leading economic research institutes expect only a moderate increase in unemployment to 2.6 million people this year in view of the "notorious" shortage of personnel in many areas, which will continue to worsen in the future. In the next two years, the number of unemployed is likely to fall slightly.

"Compared to other countries, Germany is in a good position overall, not only in terms of employment and debt sustainability," Bundesbank President Joachim Nagel said in an interview at the beginning of September. "Germany is not the sick man of Europe. I think this is a misdiagnosis that is all too easy for many people. We should be more self-confident."

What about Germany's public finances?

Despite the weak economic development, Germany is still seen internationally as a pillar of the financial system, according to Finance Minister Christian Lindner. "We are something like an anchor of stability, because our debt is going down, the debt ratio is falling," the FDP politician said recently.

mik/dpa