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Inflation: government aid will do more harm than good – Economics

At first it sounds absurd, maybe even heartless, but unfortunately it is the right way: the finance ministers of the 27 EU member states want to abstain this time. Huge economic stimulus and relief packages like those launched at the beginning of the pandemic should not be. The Federal Republic and the entire EU are in deep crisis. Citizens and businesses are suffering from high energy prices, and many economists expect a decline in German output. At the time, Finance Minister Olaf Scholz called these Covid crisis programs a “bazooka” and that Germany should turn the corner with a “boom”. Now, on the other hand, the Panzerfaust should stay in the gun cabinet.

This ministerial promise does not mean that politicians underestimate the impact of inflation and the energy crisis on consumers and businesses. But they know that a fiscal bazooka would be an inappropriate weapon. Using them will do more harm than good. Because in times of high inflation, government assistance should be as targeted and modest as possible. Therefore, citizens must recognize that the government cannot even come close to compensating for their lost purchasing power and wealth. The decisive question is whether the 27 finance ministers will stick to this difficult course. After all, there is enormous political pressure to support the population on all fronts.

Many of the EU governments’ aid programs are already poorly targeted, and this also applies to the federal government’s aid packages. These measures benefit not only those in need, but also those who receive more. And in two weeks, a coalition of conservatives, populists and the far right could come to power in Italy, the EU’s third largest economy. The alliance is attracting attention with expensive campaign promises, so there is a risk that the future finance minister in Rome will not believe in restraint.

But apparent generosity will only fuel inflation and delay a return to stable prices. High energy prices mean that a much larger share of EU citizens’ income ends up in the pockets of oil and gas suppliers outside of Europe. Accordingly, consumers can spend less on purchases and services. Their purchasing power has plummeted. This is painful not only for citizens, but also for restaurant and shop owners who have to deal with less demand.

Usually aid programs would be the preferred means, but inflation is too high.

Governments can cushion this decline in demand by increasing purchasing power. Tax cuts or caps on energy prices financed by huge subsidies could ease the burden on the general public. Usually such incentives are the right policy in an economic downturn. But this is not the case when inflation is so high. Even core inflation, excluding energy prices, exceeded 5 percent. And the longer inflation reigns, the harder it becomes to get rid of it. If the state supports demand with aid programs, this complicates the fight against inflation by the European Central Bank. After all, more demand means higher prices, especially when supply is tight, such as supply chain issues that make it difficult to produce some goods.

Therefore, large-scale aid programs are out of the question. At the same time, it is clear that governments must provide targeted support to the poor. No citizen should be forced to do without heating or light for lack of money. Measured assistance is also needed for companies whose existence is threatened by energy prices. Programs should be designed in such a way that there are incentives to reduce consumption. Targeted aid also has the advantage over the bazooka approach that it is less of a burden on national budgets. This is all the more important because the Covid crisis has already led to an increase in debt levels. If a country like Italy were to throw all discipline to the wind, the EU would face a new debt crisis in the midst of an energy crisis. You don’t want to imagine it.

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