“We expect to see recessions in Germany, France and Italy – but not in Switzerland”

What exactly is the transmission mechanism for this negative dynamic?
Kronenberg: There are two channels. On the one hand, high inflation and weak consumer sentiment in Germany are dampening demand for Swiss consumer goods. On the other hand, rising producer prices are causing output in Germany to fall, so German firms are demanding fewer intermediate products from Switzerland.

Is the strong Swiss franc also depressing exports?
Kronenberg: Yes, but not as strongly as you might think. Because inflation in Germany and many other countries is much higher than it is in Switzerland, the appreciation of the Swiss franc is not as significant. The Swiss National Bank (SNB) is of the view that the franc is currently no longer overvalued. We at KOF also think that this is plausible.

Inflation in France – currently around 7 per cent – is almost 4 percentage points lower than it is in Germany. What is the reason for this?
Mikosch: France introduced an electricity and gas price cap last autumn. That is the main reason for the lower level of inflation in France. The core inflation rate, which excludes energy prices, is about the same level as it is in Germany.

Is France in a better position than Germany in terms of growth?
Mikosch: We expect to see a recession in France as well, albeit somewhat less severe than in Germany. France is not quite as well integrated into the international industrial cycle as Germany is, so its recession is likely to be slightly milder than Germany’s.

How much of an impact will it have on the European economy if the Franco-German economic engine sputters?
Kronenberg: Germany and France are indeed the driving economic forces in Europe. Since Europe is very interconnected economically, the downturns in Germany and France will affect the whole of Europe. This interconnectedness is particularly evident in industry, where several countries are involved in the manufacture of a single product. For example, the German automotive industry had to temporarily halt production after the outbreak of the war in Ukraine because key intermediate products such as cable harnesses could no longer be supplied from Ukraine.

The United Kingdom has not been a member of the European Union since 2020 and has never been a member of the euro area. Can this country decouple itself from the weak economic performance of the EU and the euro area?
Kronenberg: No, the UK has even bigger problems than most EU countries. Part of this is self-inflicted. The former prime minister Liz Truss unsettled financial markets with her radical tax reforms and caused the pound to plummet. In addition, the UK is suffering from the consequences of Brexit, which is further fuelling inflation. Additional trade barriers since Brexit have made imported goods from the EU more expensive. What’s more, the end to the free movement of workers has increased labour shortages, which in turn result in higher wage demands. International engagement with the EU, especially trade, has also plummeted since then, and many multinational companies have withdrawn from the UK and reduced their investment. Ultimately, productivity suffers as a result, which also makes domestic manufacturing more expensive and reduces growth potential over the longer term. We expect the UK to slide into recession and experience higher inflation for a protracted period of time. The Bank of England is even forecasting negative economic growth for the UK for the next two years.

The business newspaper The Economist recently compared the United Kingdom to Italy and invented the neologism ‘Britaly’ for it. Is Britain the new Italy?
Kronenberg: Politically, the UK has been unusually unstable lately. The rapid changes of government with three prime ministers in just a few months have indeed been reminiscent of Italy. We can only hope that a little more calm will return under the new prime minister Rishi Sunak.

Italy has had a right-wing government since October. Does this pose a threat to Europe and the euro?
Mikosch: The new prime minister, Giorgia Meloni, has a few wrinkles in her coalition. But she herself has recently presented herself as a real moderate – partly in order to win a majority. For example, there is no longer any talk of leaving the euro, as was discussed in Italy a few years ago. Her coalition partner Forza Italia – unlike her second coalition partner Lega – tends to be a pro-European party. I believe that the battleground for this coalition will lie more in the area of migration and identity politics rather than in European and economic policy. In our assessment, therefore, Italy does not pose an existential threat to the euro area.

And what is KOF’s economic outlook for Italy?
Mikosch: We expect to see a recession and high inflation in Italy as well. Germany and Italy have very similar economic cycles because the industrial north of the country in particular is closely integrated into international value chains.

Let’s look at the most important economic areas outside Europe. Has the COVID-19-related supply chain problem in China now been resolved?
Mikosch: China is still pursuing its zero-COVID policy. Somehow, however, they have managed not to completely choke off economic activity, partly by adopting measures that would never be tolerated here in Europe – such as workers having to camp out at their firms for weeks on end. The supply chain issue is slowly improving. China’s real problem is that its own vaccines don’t work and the Chinese don’t want to use Western vaccines from Pfizer or Moderna on a large scale. A shift away from this domestic approach would be a real gamechanger. But China is increasingly centred on President Xi Jinping, who makes many of his decisions either on his own or in a small circle. Unlike in the past, there are hardly any checks and balances provided by a larger group of decision-makers. This poses many political risks.

Political analysts are warning of an escalation of the Taiwan conflict. What consequences would this have for the global economy?
Mikosch: The effects of any military escalation of the Taiwan conflict are difficult to assess. Chip production in Taiwan, which is so important for the global economy, could probably be relocated to other parts of the world in the medium term – even in a worst-case scenario. But what exactly would happen geopolitically after a potential occupation of Taiwan and how the United States might react is completely unknown.

Has the US economy – the growth engine of the global economy – now overheated?
Kronenberg: During the COVID-19 pandemic the US stimulated demand by launching large fiscal spending packages, which the American media nicknamed ‘Bidenomics’. As a result, the US Federal Reserve (Fed) had to prevent the economy from overheating by raising interest rates, even if it meant triggering a recession.
Mikosch: We expect to see a recession in the US as well, but there are also positive signals here. The US labour market remains robust and corporate profits are high. Moreover, the US economy is generally more dynamic than the European economy. If it slides into recession, experience shows that it recovers very quickly.

How can Switzerland protect itself against inflation and recession abroad?
Mikosch: A very important policy lever is the SNB’s management of the exchange rate. You have to look at the inflation differentials with other countries and think carefully about how much appreciation of the Swiss franc you can allow. That way you can protect yourself against imported inflation. On the other hand, of course, you must not allow it to overshoot so that it harms the competitiveness of the export sector by appreciating too much. If you can successfully perform this balancing act, this is half the battle in avoiding a prolonged crisis. We at KOF currently reckon that, on balance, Switzerland can avoid a recession despite its elevated energy prices.

Germany is trying to mitigate the effects of inflation by adopting socio-political measures such as cheaper transport tickets, a flat-rate energy tariff for all citizens and a gas price cap. Does Switzerland also need to introduce a relief package for consumers?
Kronenberg: The need to take such measures in Switzerland is not as urgent as it is in the EU. But ultimately this remains a political question.