Home > Uncategorized > Wages and the price level in the Eurozone (chart)

Wages and the price level in the Eurozone (chart)

from Merijn Knibbe
And there was weeping and gnashing of teeth when a whole bunch of Dutch economists suddenly discovered that the IMF understands that ECB means ‘European Central Bank’ and not Dutch or even German Central Bank as it stated that arithmetic dictates that:

A. when the ECB sticks to its official Eurozone 1,9% HICP inflation target

B. while inflation in Southern Europe has to be lower than the average, to increase competitivety

C. this means that inflation in Northern Europe has to become higher than the average…

Of all the information about all the countries in all the world in the IMF report and despite sentences like this:

In the core (Eurozone, M.K.) economies, growth will broadly stall in 2012, except in the Netherlands, where intensified fiscal consolidation is expected to contribute to contraction

they only read the highlighted part of this quote:

In Germany, structural reforms will be needed to boost the relatively low level of investment and, more generally, increase potential growth from domestic sources. In the near term, the underlying strength in the labor market should foster a pickup in wages, inflation, and asset prices, and this should be seen as part of a natural rebalancing process within a currency union. By way of example, inflation in Germany and the Netherlands, the other major surplus economy in the euro area, would have to be about 3 to 4 percent to keep euro area inflation close to the ECB’s target of “below but close to 2 percent,” if inflation in Greece, Ireland, Italy, Portugal, and Spain were kept around zero to 1 percent and inflation elsewhere remained in line with the ECB target. This underscores the importance of wage and spending adjustments in the surplus economies for the proper functioning of the EMU”

Well, will the Netherlands and Germany have to increase wages? Let’s take a look at wages and the (consumer)price level (graph, click here for a larger edition).

Source: Eurostat.

Clearly, wages determine a large part of the (consumer)price level and an even larger part of the differences between countries (the black line is a second degree Excel-polynomial which does not take the size of countries into account, taking these differences into account would lead to a somewhat flatter line closer to Germany and The Netherlands). And most important: wage levels explain a larger part of the price level in high wage countries than in low wage countries. Which means that a 10% decrease in wages in low wage countries has a lower influence on the differences in price levels not just because -10% of €5,50 is a bit less than +5% of €25,50 – but also because wages are a smaller ‘part’ of the wage level in low wage countries (the other part of course consists of things like oil and other ‘highly tradables’). If we want to increase differences in the price level, increasing wages in high wage countries (with very large surpluses on the current account) seems the smarter way, surely in a situation were spending is already below potential.

P.S. – the total price level including investment and the government would be a better yardstick and Denmark has an overvalued currency because of ‘financial rigidity’, i.e. sticking to its Europeg.

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