Germany and France could make life easier for the ECB

Prices rise faster in Germany than in France, contrary to a long tradition. But the collective wage bargaining that prevails in both economies means the duo have a common problem: rising wage deals can drive companies to raise prices further. With a bit of fiscal creativity, Macron and Scholz could mitigate risk by helping households. That could reduce the pressure for big pay rises, and help the ECB.

The annual inflation rate is 7.8% in Germany and 5.4% in France. Driven by industrial exports, the German economy has suffered from supply chain problems, which have not affected its neighbour’s service-oriented economy to the same extent. Germany’s greater dependence on Russia also explains part of the difference.

But the fiscal stimulus has boosted cost pressure less than in the US. That leaves room for Berlin and Paris to roll out targeted fiscal transfers to cushion the damage on consumers. When energy prices started to rise, Berlin and Paris responded with foolish and sensible policies. Foolish when they tried to force down the prices of energy and gasoline, which does nothing more than encourage consumption. Sensible when the subsidies were directed to the most disadvantaged.

The Ukraine war has added another layer of inflation. Government debt to GDP rose during the pandemic, but higher prices mean inflation-adjusted rates remain negative. Governments therefore have some room to maneuver to lend a helping hand to consumers without jeopardizing debt sustainability. This may encourage workers to demand more moderate wage increases, which in turn would help prevent high inflation from taking hold.

That would make the ECB’s job easier. Anything that reduces the chances of a price-wage spiral will help reduce the need for a growth-damaging ECB policy tightening.