Structural reforms and macro-economic policy - ETUC

Structural reforms and macro-economic policy
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The internal dimension of wage-price flexibility stems
from the fact that wages are not just costs, but also
incomes. As a result of ‘wage moderation’, wageincome
earners in Germany are confronted with
moderate disposable income growth, which comes on
top of general job market uncertainties and SGPimposed
budget cuts.While there are few better ways
to depress private consumption growth, as Figure 7
shows, the opposite has been true in Spain, where on
top of a booming job market, private consumption
also found support from less moderate wage rises.
The point is that private consumption tends to be the
most important GDP component. Especially in larger
economies, private consumption typically has much
greater weight in GDP than exports. Even as the
external dimension of wage-price flexibility may
boost net exports and GDP, its internal dimension can
provide an overwhelming drag on growth.
How divergences are amplified
by financial propagation mechanisms
It is highly doubtful whether a large economy (such as
the euro area) should run a growth strategy that relies
on external competitiveness gains, especially in today’s
environment of global imbalances. It is true, though,
that wage moderation can also boost employment
other than through external competitiveness gains,
namely by forcing expansionary monetary policy upon
the central bank. It is through its disinflationary effects
that wage moderation provides an avenue to employment
growth through domestic demand, at least if the
monetary policy-maker complies and boosts domestic
demand accordingly.
In the case of the US, this channel is quasi-automatic.
Let us recall that the US Fed has a clear double
mandate: maximum employment and price stability.
As the economy slumps, the Fed is therefore bound to
ease policy, so as to support employment. But even in
the case of an inflation targeter like the Bank of
England, for instance, a growth slowdown elicits
monetary easing, namely through its impact on wage
dynamics and the inflation forecast.
Although the ECB, too, is mandated to support
economic growth and employment, ‘without prejudice’
to its primary goal of price stability, important
complications arise here due to the ECB’s idiosyncratic
interpretation of its role. One key problem is
that, in the ECB’s view, price stability by itself is
always the best contribution that monetary policy
can make to any other goal. Another key problem is
that it is not so much forecast inflation but past
inflation which seems to guide the ECB. The ECB’s
rear-view mirror approach has had a vastly detrimental
effect on economic performance: after
choking growth through its aggressive interest rate
hikes back in 2000, the ECB then failed to ease in
time as the productivity slump (2001-02) and taxpush
inflation (2002-05) kept inflation above its selfdeclared
two per cent tolerance level (Bibow 2005b).
While no one else but the ECB is responsible for
these serious policy blunders, monetary policy is not
to blame for the following complication, which is,
however, intimately related to wage and inflation
divergences within the euro area. Instead, individual
member states have to be aware that the quasiautomatic
route between wage moderation and
monetary easing is blocked in a currency union. In
fact, wage moderation in any one member country
relative to the average can even backfire. The point
is that the disinflationary impact of national wage
moderation on national price inflation only reduces
euro area inflation by the respective country’s
weight in the overall HICP. Thus, at best a partial
reward from the ECB may be triggered in this way. If
inflation increased elsewhere in the currency union
at the same time, not even a partial reward would
be forthcoming. This is because the monetary policy
domain and the domain of wage moderation are
not the same – unlike the situation in Germany
under Bundesbank rule. Making things worse still,
today, as German inflation declines relative to inflation
elsewhere in the euro area, German real
interest rates rise both absolutely and relative to the
euro area average.
But this is not where the story ends. Diverging real
interest rates – driven by wage-price flexibility and
inflation divergences – will be likely to trigger important
propagation mechanisms in the financial
system. In particular, while negative real interest
rates are likely to ignite a lending boom in Spain, with
rising asset prices and improving creditworthiness of
borrowers leading to more credit ease, quite the
annual percentage changes
20
15
10
5
0
-5
Figure 8: Residential property prices
97-00 2001 2002
Spain
Germany
2003 2004
SOURCE: ECB MONTHLY BULLETIN, FEBRUARY 2006