Economic turmoil tests G7’s ability to deliver united response

Just six months in office, Olaf Scholz hosts Sunday’s G7 summit at a time of peril for the west, as soaring inflation, an energy crisis and the threat of recession test the wealthiest economies’ ability to deploy a co-ordinated response.

The meeting — also attended by the leaders of the US, UK, France, Italy, Japan and Canada — comes as economists across the world downgrade their growth forecasts and revise up their inflation projections. Energy and food prices have spiralled higher since Russia’s invasion of Ukraine in February, and this month central banks have raised rates by bigger margins than markets expected.

“It would have been impossible to imagine at the last G7 summit that we’d be facing a situation like this,” said Holger Schmieding, chief economist at Berenberg Bank. “Things are pretty bad and could get even worse.”

The dire outlook was underlined last week when Germany took a step closer to rationing gas after a sharp drop in Russian deliveries through the Nord Stream 1 pipeline.

Scholz said the main aim of the summit, held at the luxury resort of Schloss Elmau in the Bavarian Alps, was to project unity. Leading democracies must show they are as “united as never before”, not only in the “struggle against [Russian president Vladimir] Putin’s imperialism, but also in the fight against hunger and poverty, health crises and climate change”, the chancellor told the Bundestag on Wednesday.

Scholz will notably push for a “Marshall Plan” for Ukraine, modelled on the American scheme that bankrolled Europe’s postwar reconstruction. Ukrainian president Volodymyr Zelenskyy will take part in the summit by video link.

Leaders will also discuss the disruptions to global food supplies caused by Russia’s blockade of Ukraine’s Black Sea ports. It was incumbent on the G7 to “prevent a catastrophic famine”, said Scholz, who has also invited Indonesia, India, South Africa and Senegal to the summit.

But a common policy response might be harder to reach on the looming macroeconomic threats to the G7 states themselves — discussion of which will dominate the first day of the summit.

Some of the recent developments are seen as outside the leaders’ control: China’s zero-Covid policy playing havoc with global supply chains, and the Kremlin’s reduction of gas flows to Europe, which has rattled gas markets and increased the odds of winter energy crunch.

“It’s not the G7 leaders who have caused these problems — it’s [Chinese president] Xi Jinping and Vladimir Putin,” said Schmieding.

That contrasts with the Covid-19 pandemic, when governments embraced massive fiscal support and monetary stimulus to shield businesses during lockdowns. Then there was, said a senior German official, a “simple consensus” on how to respond — a “textbook macroeconomic answer, namely an expansive monetary and fiscal policy”.

“The situation we’re in now is a lot more complex, a lot more difficult,” he added. “This completely clear, almost instinctive idea that you just pursue expansionary policies is no longer so obvious.”

This time, said Paschal Donohoe, president of the eurogroup of finance ministers, policymakers will have to strike a balance between supporting households most exposed to surging energy prices and taking care not to stoke inflationary pressures — a task he described as “demanding”.

“This is a very difficult challenge for central banks and for governments,” he said in Brussels on Friday. “History shows us that if inflation becomes a multiyear phenomenon at very high rates, the challenges we face in the cost of living only grow.”

The US has been holding talks with European leaders on how to ease the pressure on energy prices. The focus, officials said, is on ways to prevent G7 restrictions on Russian oil from pushing crude prices higher and bolstering Putin’s export revenues.

One answer that has long been pushed by the US, and will be discussed at Schloss Elmau, is a cap on oil prices paid to Russia. It would require changes to Europe’s ban on insuring Russian oil shipments: a compromise might allow countries to obtain insurance if they observe the price cap.

But Scholz is lukewarm on the idea. On Friday he said that it was “no good” if just a few countries complied with the oil price cap — it would only work if everyone did. “[Oil] demand is global,” he said. “And unless we can get everyone on board, or nearly everyone, then it won’t be so effective.”