Incautious Statements and/or Bad Journalism give wrong Message on Wages

It is hard to know whether ECB President Trichet is more to blame or the Reuters reporters. But what is clear is that a wrong message is sent on the key issue of wages by reports such as this one, which muddles up a number of issues.

President Trichet is correct, in principle, to stress that so-called ‘second-round effects’ should be avoided. This occurs when temporary rises in certain commodity prices (especially energy) feed into nominal wage growth and thus become permanent. At some point the central bank steps in to break this process and the result is higher unemployment. Early interest rate hikes are the last thing the European economy needs.

But there are a lot of buts.

They start with the title:

ECB’s Trichet says wage rises would be folly

Even granted the need for a headline to be succinct this is economic nonsense and, worse, it is inflammatory. It is a red rag to workers and trade unions rightly appalled by the distributional bias in resolving the crisis and the threat to living standards posed by downward wage pressure and unemployment. Wages should of course continue to rise in line with productivity plus the medium-term inflation rate, or the central bank’s target rate (and not the current inflation rate – this is the bit that M. Trichet has right); see here for an explanation.

Then the different euro area countries are mentioned and things fall apart even more. Germany is mentioned, but there wages should be growing faster than this norm. Why? because Germany needs to adjust for years of excessive wage restraint and must reduce its massive trade surplus which is squeezing the air out of the lungs of countries like Ireland, Greece and Spain that desperately need faster demand growth. The corollary is slower nominal wage (and also price) increases in those countries. (‘Slower’ here means less than the sum of their respective productivity growth plus the ECB target.)

Last but not least the trope of abolishing wage indexation gets thrown in. This is a huge red herring given undeserved attention by the Franco-German ‘competitiveness pact‘ (but which Trichet and other central bankers have been guilty of rabbiting on about). Intelligent wage indexation schemes, such as those used for decades in Belgium and Luxembourg, which notably include provisions that avoid changes in imported prices feeding into nominal wage setting, can be useful instruments to stabilise expectations. In the countries that use them they are embedded in complex industrial relations and social partnership systems, and it is folly to simplistically call for their abolition. It also distracts attention from the much harder but vital task of working towards greater cross-border cooperation in wage setting.

The only sensible wage norm in a monetary union is the ‘golden wage rule‘.