Fabio Sdogati

2017 08 08

 

“But let me [Draghi] just make clear one thing: after a long time, we are finally experiencing a robust recovery, where we only have to wait for wages and prices to move towards our objective.”

The bottom line

By announcing that waiting is all that’s left to do in order to get wage and price inflation, the ECB shows that she has no clear idea as to how profound are changes that are affecting labor markets, nor about the effects that such changes have on the supposed effectivness of monetary policy. I submit that labor markets have been transforming in such a way that the chain of links growth-> wage inflation -> price inflation, has to a large extent broken down (Germany my be a partial exception). The implication is the same I, and many others, have been drawing for years: it is fiscal stimuli that generate growth-cum-wage-rises, not monetary stimuli. (Something, to be honest, Mr. Draghi points out, in politically correct terms, at every press conference.)

I have identified two parts in the introductory statement to the July 20 ECB president’s press conference: one, which few will object to my calling boring and repetitious: I will not discuss this part; and another, which I believe to be most interesting, and will therefore discuss in some detail.

1. The repetitious, boring policy announcement:

1.1 Policy announcement: not much to speculate here

“..key ECB interest rates unchanged. We expect them to remain at their present levels for an extended period of time, and well past the horizon of our net asset purchases. Regarding non-standard monetary policy measures, we confirm that our net asset purchases, at the current monthly pace of €60 billion, are intended to run until the end of December 2017, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim.”

1.2 More of the same: Heavy doses of camomile tea for the benefit of bondholders

“We reviewed the economic and financial developments in the euro area, where we took stock of the continuing improvement in growth momentum, but also of the fact that the inflation rate is still subdued – and really there isn’t any convincing sign of pickup for underlying inflation – while noting that the headline inflation will still be fairly volatile in the coming months. There was a general reiteration of the point that convergence of the inflation to our objectives remains conditional upon the very substantial monetary accommodation that is now in place.”

Translated into plain English: fear not, bondholder, when you see a “continuing improvement in growth momentum”: we are not going to tighten, since underlying inflation does not show “any convincing sign of pickup”.

2. The interesting part: Why is inflation not showing up, despite su much easing? Wasn’t inflations always and everywhere a monetary phenomenon?

So, the excerpt under 1.2 above repeats in part what is said in excerpt one, but in doing so it introduces the spectre of growth: growth, we are told, is finally coming, but without price increases. Good growth, would probably say those who believe to be the re-living the 1970’s and 1980’s all over again. Bad growth, says I: how come growth does not spur inflation?

Now, at the cost of being boring, one is obliged to remind the reader, one again, that the ECB remit has not to do with growh, just with price stability. So, why is the governing council talking about growth? Surely, as we already said, to reassure bond holders that not even growth should concern them; but, let me ask, isn’t ECB telling us that she has been, and still is, expecting inflation from growth? (And since there is growth but no inflation, then quantitative easing must go on…). This is interesting, because it would indicate that the ECB has been imagining (no disrepect intended)  a chain of causality  going from negative rates and quantitative easing to growth, and from growth to inflation. Well, Keynes anyone? It would seem plausible to think that negative rates and gargantuan amounts of liquidity injected in the banking (and large-capitalization firms) system is not being loaned/borrowed for the purpose of expanding economic activity and, through it, employment, employment income, consumption expenditures, etc. A rather well known phenomenon: it is a liquidity trap.

Let us focus now on the second link in the chain, growth to inflation (I am not interested in discussing here the implied link QE to growth). The obvious question here is: what exactly, in the ECB governing council’s mind,  ensures that growth lead to inflation? Astonishingly, the communiquè offers an answer that reminds us of Mr. Trichet and his approach to the financial crisis: confidence does it! Just in case you do not believe me, here is Draghi talking:

“So, all in all, one could try to summarise the exchange of views we [the governing council, fs] had sayingthat it was around the concepts that we’ve expanded on on other occasions, like the concept of confidence that is basically generated by the growth momentum..”

Were it not to cry, one would be tempted to laugh: confidence generated by a growth momentum (a pathetic one, to be sure) that escludes growth of labour income and consumption expenditures? Mah.

And now, finally, the story gets interesting. Read this:

“But let me [Draghi] just make clear one thing: after a long time, we are finally experiencing a robust recovery, where we only have to wait for wages and prices to move towards our objective.”

What is the reasoning behind such claim? Here it goes.

Even though economists are not nearly as single–minded as many seem to think, It is generally accepted that some kind of relationship must exist between aggregate demand, unemployment, wage growth and price inflation. Now, this is not the place to attack the problem of the causal relationships linking each of these variabiles to each other; rather, we will be content to say that it stands to reason that a decrease in unemployment, whatever the reason for it, should sooner or later lead to rising wages and thus to price inflation. A bit more technically: if supply capacity does not grow as fast as aggegate demand does, then something like that has to happen.

But: are we sure? Does the process just outlined work the same way whether growth starts at very high levels of unemployment (say, 10%, as was the yearly average in the US and EMU in 2010), or if it does from relatively low levels of unemployment (say, below 5%, where it stand in the US as we write)? Our question is not trivial:  when unemployment is high unemployed labor is abundant, and growth of factory orders can be met relatively easily by hiring at substantially stable wages. But when unemployment is lower, when labor supply is tight, then additional output can only be produced at growing, albeit shlowly, wages, as employees have to be lured away from their existing occupations through better conditions and higher compensation.

Or so we have been thinking for decades.  But then, why do we not see inflation in the EMU despite growth has been picking up (says the ECB)? Sure, one can dub this ‘recovery’ a jobless one, but then one would like to see sizeable increases in productivity, something that one does not really see in many EMU member countries. So the question becomes: is it really just a matter of sitting back and stop being impatient? We really ought to “sit back” and wait, the job is done, only problem being the result is not there yet for the ordinary man to see!? My answer to that is: no, it is not a simple matter of leads and lags, matters are more complex, and especially more complex is the structure of labor demand.

To make my point, I turn again to the chain of events leading from growth to inflation, and especially focus on the link: falling unemployment-> rising wages. Is that a fact? What, or who, does the adjusting of wages to lower unemployment? More explicitely: does ‘the market’ do the adjustment? Are there no institutions involved, no collective bargaining, just myriads of one-to-one, one worker – one firm agreements?

Of the two scenarios, let us begin with that  in which both employees and employers belong to a union. One imagines that when demand for goods and services increases, firms notice. They will probably not proceed to direct and immediate additional hirings, but would most probably ask for overtime, greater number of shfts, in short those measure that allow to mobilize capacity hitherto left idle. Labor unions, even if not alerted to such changes by the firm, would be alerted by members seeking protection and better conditions. Just as union members will report the change to the union, so the firm will report, as it is standard procedure, to its association.

So, in this scenario a pick up in economic activity is no small, private matter, something to be dealt with on a one-to-one basis, unless it is a very minor, localized phenomenon. The generalized (not necessarily big) increase in capacity utilization will likely lead labor unions to ask for bargaining sessions where to discuss proposals for better working conditions, better pay, better retirement benefits. And there will be such meetings at the firm, territorial, and national levels. In short: in the context examined here, an increase in labor demand generates a process leading to policies being discussed and bargained upon. Which is tantamount to saying that there is a system of governance of the relationship beween growing employment and wages. Wages grow because there are labor unions.

In the second scenario there are no trade unions. Just as in the previous scenario, an unexpected increase in goods demand will lead firms to seek extra time and longer shifts from their employees. The difference is that such request will have to be extended a number of times, as many times as there are employees potentially affected. The second difference is the bargaining power of the employee, now obviouly weaker relative to that exercised in the first scenario. The all-governing structure of the labor demand – wage growth collapses into the firm-employee relationship.

We finally got there. Assume that this (pathetic, says I) signs of growth are actually there: where is the wage inflation? There is none in sight, says (correctly) the CEB president’s opening statement: to be repetitive “we are finally experiencing a robust recovery, where we only have to wait for wages and prices to move towards our objective”. The question is still there: why exactly do we have to wait even longer??

The answer is that we can imagine that all were needed is to wait longer, perhaps, if the structure of industrial relations were the same we grew accustomed to in decades past.  But it no longer is. Reading what has been written about sharing economy, gig economy, and all the other fantastic economies in the making, we can learn that labor compensation is falling and labor protection is disappearing fast (I had a chance to write a few thoughts about this in times past). Each of us will have a chance to say whether this is a good or a bad, but all will agree, I hope, that wage growth is not in the immediate vicinity. Nor is inflation.

Conclusion (The Financial Times, commenting on the August 4 US labor data release)

Americas jobs recovery continued unabated in July, fuelled by a surge in hiring at restaurants and bars