ETUC urges European Central Bank to cut rates and bolster confidence in the economy
The continuing absence of real recovery is taking a heavy toll on wage formation. Real wage increases for the euro area as a whole were absent in 2004, and for 2005/2006 the pace of nominal wage increases continues to move downwards. This implies that there is no danger whatsoever of inflationary second-round effects coming from high oil prices. Instead, the danger is one of excessive wage moderation moving the euro area closer to the edge of deflation. To avoid such an outcome, the ECB needs to reassure the European public that it has a double mandate: to defend price stability and keep the economy operating at full potential. The ECB can begin to do so by cutting interest rates as soon as possible.
Said ETUC General Secretary John Monks: “The model of ‘competitive disinflation’ is a dangerous policy for a relatively closed economy the size of the euro area. ‘Competitive disinflation’ is not resulting in more jobs and investment but is instead running out of control and generating ‘competitive instability’. The ECB needs to give up fighting the inflation battle of the past and instead cut interest rates to support growth and strengthen economic confidence.”
Main messages from the ETUC’s report:
The continuing slowdown in the euro area is ‘home made’. It has to do with failure to implement counter-cyclical measures. In particular, monetary policy conditions have become substantially less accommodating since the start of the slowdown: interest rate cuts were insufficient to compensate for the negative effects of the appreciation of the euro.
The ECB’s reluctance to conduct an active counter-cyclical policy can be explained by the model of ‘competitive disinflation’. In this model, the central bank does not need to intervene to stabilise the economy. Instead, economic growth is supposed to come from export demand being triggered by wage moderation. However, with exports limited at 20% of total GDP, the euro area risks destroying domestic demand dynamics in going down the road of extreme wage competition.
The pace of nominal wage increases is falling and the bottom of this downward trend in wages is nowhere in sight (see graph). Unit labour costs (around 0.5% for 2005 and 2006) are much below the ECB’s price stability target (2%). This will push inflation further downwards.
A similar scenario operated in the ’97-’99 period. During that time, unit wage cost increases were also limited and resulted in the inflation rate falling as low as 1%. This downward spiral was then halted by importing inflation through a steep depreciation of the euro’s exchange rate. However, given present global imbalances (US record-high external deficit), the euro area cannot count now on a new ‘bail-out’ from exchange rate markets to avoid the process of competitive disinflation from spiralling out of control.
This implies that the ECB is on its own in preventing the economy from slipping into a ‘meltdown’ scenario. Interest rates need to be cut, by around 500 basic points at least. But what is also key to recovery is restoring confidence among households and enterprises. The ECB should help by clearly accepting the double mandate it has been given by the European Treaty: to defend price stability and to support economic growth. European monetary policy needs to be remodelled to become symmetrical, forward-looking and responsive to situations of low inflation in which the usual trade-off between growth and inflation has disappeared.
Full ETUC report available at: ETUC report
Wage formation - where is the bottom?
Source: Commission DG II web site,indicators euro area
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