This commentary helps shed some light into the current economic conditions in Germany and its effects on unemployment and inflation.
Economic growth is one of the four macroeconomics objectives. It is defined as an increase in the potential gross domestic product (GDP) of a country over a sustained period of time. From the article, it is forecasted a “2.3 percent growth” in the German economy owing to an increase in the aggregate demand (AD) defined as the total quantity of aggregate output, or real GDP, that all buyers in an economy want to buy at different possible price levels, ceteris paribus.National inflation rates are expected to rise to “1.9% in 2018 and 2.2% in 2019”. A possible cause is demand-pull inflation, in which due to an increase in AD brought about by increased consumer spending and investments from firms, this has caused price levels to rise as illustrated using the monetarist model below.
Figure 1.1: Demand-Pull Inflation experienced by Germany’s economyFrom the graph above, a rightward shift in AD from AD1 to AD2 has resulted in an increase in general price levels from Pl1 to Pl2, and it is generally associated with an inflationary gap as the real GDP (Y2) is greater than full employment GDP (Y1). This inflationary gap experienced is attributed to several factors such as “low borrowing cost” which culminated in increased consumer spending and investments from businesses. Moreover, an increase in the consumer or investment component of the AD would likely result in a multiplier effect on the final real GDP. For instance, an initial increase in investment spending in the manufacturing sector would trigger a chain of induced spending, in which owners of the factors of production such as land owners and factory workers would receive a larger income, which would then translate to a larger consumer expenditure, which could constitute to a larger increase in real GDP.Delving further into the relationship between the growing inflation rates and falling unemployment, the Phillips curve suggests that there is a negative relationship between the inflation and unemployment. Figure 1.
3: Phillips curve of Germany’s present economyFrom the Phillips curve above, the different points on the curve represent different possible settings of an economy. Germany’s present and forecasted economic lookout seem to point towards a movement along the Phillips curve from point B to point A with record high employment levels of “44.3 million employed this year” and a gradual increase in inflation rates. In the short-run, Germany’s economy seem to follow the the theoretical relationship as illustrated in the Phillips curve. In evaluation, this is based on the assumption that int he short-run the wages are a constant. Therefore, if price levels increases, firms would profit more as a result, and therefore increase their output. This has an consequent impact on increasing the real GDP as well as lowering the levels of unemployment.
However, in the long-run, this theoretical relationship will not hold true. All resource prices including wages would change to match the changing price level and therefore an increase in price-levels would have no impact on the GDP of Germany but it would increase the amount of AD in an economy with the unemployment rate fixed at the natural rate of unemployment unaffected by changing the rates of inflation. In addition, the short-term economic growth is in part supported by its “exporters benefiting from a global economic recovery.” Figure 1.3: Business Cycle DiagramWith reference to a business cycle diagram below, many global economics are experiencing a recovery period in which the economy seeks to regains its momentum and exceeds peak employment and output levels achieved prior to the economic downturn. In the short run, expansionary fiscal policies such as promised tax cuts “for mid-income families and increased state spending on education.” would be effective in maintaining a positive growth of the real GDP. These policies, defined as an manipulation of the government’s budget to influence the level of AD, may be possible in the short-run due to record government budget surpluses of over “150 billion euros”.
With prior successes of sustained economic growth in the German economy, the assumption therefore that such policies would be continue to bring about economic expansion in the long-run is false. With reference to the business cycle, the economy would be bound to experience a series of economic expansions and contractions in which such fiscal policies financed by the government’s budget will not always be the most effective in ensuring a steady economic growth and inflation levels and consistently low levels of unemployment.