Explanation of the inflation trend

The question asked the identification & explanation of the inflation trend over twenty years. I have chosen German as my country because of it uniqueness. The essay only discussed West Germany and not the east then the United Germany due to the huge different in economics and lack of space. Also I assumed that the theories & interrelationship between varies economic indicators is welled understood. Inflation can be define in several ways. 1)a steady increase in the supply of money (Monetarist explanations), 2) Demand persistently exceeds supply. (Phillip curve) but generally there is a general rising price persistency.

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There are varies type of inflation, i. e. : Hyperinflation, Suppressed inflation, Creeping inflation & Unanticipated inflation. Moreover ,generally 2 inflationary process-1)Demand Pull & 2)cost-push inflation. The economic system of Federal Republic of Germany is Soziale Marktwirtsh1. The states play an important regulatory role and economics policy is based on the Stability Act2. Due to ingrained fear of inflation experienced in 20s & 40s, this has led to a conservative monetary and fiscal policies which is the objectives of Bundesbank3 and the government.

Over the past twenty years, the inflation trend can be divided into 4 phase/section-1)1978-84 ,2)1984-90, 3)1990-93 & 4)1993-97. 4 I will discuss each phase individually. In Germany, Bundesbank has a very anti-inflationary biased behavior. This traditional strong fiscal prudence approach has only been interrupted twice since the Second World War. During late 1970s the shock of 2nd oil crisis had lead to a slackened growth rates in Germany and in 1978 the Government planned increases GDP 6 to boost world economy.

Numerous unfortunate side effects resulted-Inflation increased by 2% , current account became negative7 and public deficits increase over the next few years8. Moreover, the shift in distribution of income led to a squeeze on profits and Kay Page 2 5/8/2007 unemployment did not fall appreciably. Alternatively, the income policy collapsed9 and led to increase unemployment and upsurge in inflation Moreover Pressure from other European government to pursue a more expansionist & accommodating fiscal policy that mirrored by others central banks.

The crisis is being smooth over the 80s with Germany strong export trade accompanied by rigid economic policies. In 1982, there is a changes in government which lead to initial increase in Unemployment, inflation & public deficits couple with decrease of GDP, Productivity, Wages and current account. The new Government then change policies & started to sell its assets in the industry 10 hence saw the increase in current account.

We observe a 100% rise in unemployment rate figure after1980despite the fact that output rises continuously and couple with very good rates. It grow gradually from around 3-4% to 8-9%, it’s the phenomenon of hysteresis. Bundesbank anti inflationary aim created a very high interest rates in the mid 80s which lead to a clock-wise inflation-output loop11 in 1986. So even when the annual GDP has been increase and the current account is healthy and decreasing deficit—the rate of unemployment has a negative effect12 compare to change of prices(inflation).

This is due to the wages/interest rate increase not paid for out of higher productivity are then passed on to customer. Additionally, Bundesbank policies to keep inflation low irrespectively to the costs. The unemployment rates continue to be high annual GDP over the whole 80s. This is intensify when East ; West Germany reunion and the labours from east came to the west to find jobs. PHASE 3 (1990-1993) In this phase ,2 most important event happened 1) the unification of Federal Germany in 199013 ; 2)

Recession in 1992.over this period inflation start climbing so is the Unemployment due to the immigrants from east Germany. The overall GDP got into a slack although productivity is increased. Kay Page 3 5/8/2007 When in the late 80s ,Bundesbank observed inflation rate closely ; when they see that inflation is rising in 1987-89, they apparently tightened the monetary police by rising interest rate to keep inflation under control. 14 But in 1990, the economy slow down due to the falling of the Berlin wall.

The unification was accompanied by fiscal policy of full integration ; a level up of raising wages, social security/welfare in the east etc. This caused a huge boom in demand and enormous costs, which led Germany into its most serious economic crisis since the War. This problem is compound by the fact that West Germany Government did not increase income (taxation) or lower expenditure pushed the current account into negative ; deficit sky high. The immediate impact was at first a economic boom in late 80s but then the budget and capacity could not cope.

Federal government has struggle to bring spending under control15, Bundesbank try to tighten its monetary policy in 1992-3 16 which in turn led to a full blown recession in 1993. Recession over Europe has hinder/delay the recovery by export trade17 in the economic crisis. Hence production although albeit increased but has extended to enlarged Domestic market, in turn causing inflation to rise to 5. 1% in 1992. However in 1993, rising corporate profit, achieved through much rationalization ; lower interest rate led to a fragile recovery. PHASE 4 (1993-1998)

In this phase we can observed that in recovery stages, with the tightening of monetary policy the inflation descends gradually with the increase in GDP. Moreover, In preparation to the single EMU18, all European currency had to pegged closely to each other and this involved the setting of interest rate in Germany. Following the crisis, the economy gradually pick up speed with the construction price stabilized and export prices steady and the relative strength of Germany export. Bundesbank tighten its policy in response to high 94’s wages settlement and weak European demand.

the recovery was led by export trade and the weakening of D-mark in 96-97. Moreover with the stage 2 of the implementation of EMU in1994 see the establishment of European Monetary Institute, Germany has to accommodate its policy inline with the common monetary policy. To Achieve this . , 1)German has to suppress its inflation within 1. 5% of the average member states during previous years. 2) Annual deficit should not exceed 3% of GDP and 3) Interest rate must not be above 2% of the comparable rate of the country with the lowest inflation. Kay Page 4 5/8/2007

Hence it is very important that all members states demands nominal convergence in inflation rates and Germany had experience a deviation from the EMU criteria in 1996 with the deficit exceeding GDP. FUTURE(conclusion) Germany’s medium-term economy outlook is stable ; certain, despite the fact that D-mark will be abolished next year. GDP growth around 2. 2 in 1997, should continue in the 2-3% range in to millenium with export demand growth accomplished by enlarge domestic demand. Inflation which is only 1. 3% in Jan 98 will be held below 2% and exchange rate against dollar will be more stable with the establishment of European Central Bank.