In the last few days of his term, outgoing Bundesbank President Axel Weber appeared extremely satisfied with how effectively he had done his job. Looking back on seven years as head of the German central bank, he said, "we actually achieved quite a lot." Everywhere Weber goes, people rave about Germany's rapid economic recovery. In other words, things couldn't be better -- that is, if it weren't for a nagging problem that threatens to overshadow all the positive news, Spiegel Online reported.
Weber himself describes it in banker-speak: "Along with the economic upswing, we see a deterioration in the price outlook." In plain English: Prices are threatening to spiral out of control, and inflation is rearing its ugly head again.
The latest figures are indeed unsettling. Compared with the same month last year, consumer prices in Germany rose by 2.4 percent in April -- the biggest increase since the outbreak of the financial crisis in 2008.
This means that, for the fourth month in a row, the inflation rate in the euro zone's largest economy has been above the threshold of what the European Central Bank (ECB) considers compatible with general price stability, namely two percent.
Weber, who shares the central bankers' traditional aversion to inflation, already predicts difficult times ahead for the German economy: "We cannot rule out that over the coming months we may even see a three in front of the decimal point."
Others are even more pessimistic: "We will have to get used to the fact that Germany will have inflation rates of between three and four percent in the coming years," says Clemens Fuest, an economist at Oxford University and a member of the Scientific Advisory Board of the German Finance Ministry. Olivier Blanchard, the chief economist at the International Monetary Fund, has repeatedly told the Germans that they will have to come to terms with an annual inflation rate of around four percent.
Many German politicians would tend to agree: "I expect us to see higher inflation levels than previously in the coming years," says the chairman of the Finance Committee, Volker Wissing, of the business-friendly Free Democratic Party (FDP).
The last time statisticians recorded inflation rates of four percent in Germany was 20 years ago, when the boundless enthusiasm surrounding German reunification drove up prices. Once again, an economic boom is fuelling inflation. Germany's economy is moving ahead at full steam. The country seems to have made up for nearly all the losses incurred during the financial crisis, and many companies are working close to capacity.
The ECB faces a dilemma. Its mandate is to pursue monetary policy for the entire euro zone, not just for one country, no matter how dominant that nation may be. The central bank must take into account the needs of all member countries -- and many of them, especially the peripheral southern nations like Greece, Portugal and Spain, are still mired in recession or struggling with stagnation.
There is no relief in sight for these stragglers -- quite the contrary. Figures released last week by Eurostat, the European Union's statistical office in Brussels, show that the 2010 Greek budget deficit was higher than expected at 10.5 percent of gross domestic product. At the same time, yields on Greek, Irish and Portuguese government bonds reached record highs last week -- a sign that investors expect these countries to undergo debt restructuring, despite all official statements to the contrary.
Out of consideration for Europe's most troubled economies, the ECB cannot raise the base lending rate nearly as much as would be necessary to contain price pressures in boom countries like Germany. If it did, their borrowing costs would rise even further, choking off what feeble growth the southern European countries are experiencing. Read more.
