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Improving the macro policy mix by strengthening the Macroeconomic Dialogue

Improving the macro policy mix by strengthening the Macroeconomic Dialogue

Presentation to the ETUC Conference ‘Delivering the Lisbon Presentation to the ETUC Conference ‘Delivering the Lisbon goals: The role of macroeconomic policymaking’goals: The role of macroeconomic policymaking’

International trade Union House, Brussels International trade Union House, Brussels

1/2.03.2005 1/2.03.2005

awatt

Andrew Watt

2

Structure of the presentationStructure of the presentation

1.1. Is it broken? Evidence of failure of policy coordination and Is it broken? Evidence of failure of policy coordination and unnecessary output and employment lossesunnecessary output and employment losses

2.2. The key importance of the macro policy mix – a simple The key importance of the macro policy mix – a simple theoretical modeltheoretical model

3.3. From model to reality – some real-world problemsFrom model to reality – some real-world problems

4.4. Policy coordination in an uncertain world: the coordination Policy coordination in an uncertain world: the coordination potential of a developed MEDpotential of a developed MED

5.5. Conclusion – a politically feasible, growth-friendly policy mix Conclusion – a politically feasible, growth-friendly policy mix for Lisbonfor Lisbon

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Policy conflicts at root of employment problemsPolicy conflicts at root of employment problems

1.1. HistoricallyHistorically interest rate spikes in response to inflationary interest rate spikes in response to inflationary pressures have been at the cause of investment contraction pressures have been at the cause of investment contraction and higher unemployment.and higher unemployment.

• Capital-stock and hysterisis effects have made some of this unemployment ‘structural’

2.2. More More recentlyrecently, in 2000 interest rates were raised further than , in 2000 interest rates were raised further than necessary in anticipation of higher wage claims that did not necessary in anticipation of higher wage claims that did not materialise materialise

• Europe still has not returned to potential growth

Source: European Economy no. 4, 2002: Tables 3, 19, 24, 49: own calculations Note: real interest rates time series not available for EU15.

4

Investment share and unemployment, EU15, 1961-2001Investment share and unemployment, EU15, 1961-2001

15

16

17

18

19

20

21

22

23

24

25

61 65 70 75 80 85 90 95 00

2

4

6

8

10

12

Investment share (lhs)Unemployment rate (rhs)‘Real’ short- term rate, Germany (rhs)

Source: ECB Monthly Bulletin February 2002, February 2001, Sept. 2000 5

ECB main refinancing rates, inflation and real growth, 1999-2002ECB main refinancing rates, inflation and real growth, 1999-2002

0

1

2

3

4

5

Jan

-99

Feb Mar

Ap

rM

ay Jun

Jul

Au

gS

ep Oct

No

vD

ecJa

n-0

0F

eb Mar

Ap

rM

ay Jun

Jul

Au

gS

ep Oct

No

vD

ecJa

n-0

1F

eb Mar

Ap

rM

ay Jun

Jul

Au

gS

ep Oct

No

vD

ecJa

n-0

2F

eb Mar

Ap

rM

ay Jun

Jul

Au

gS

ep Oct

No

vD

ec

ECB base rateHICPReal GDP

(Source: ECB Monthly Bulletin June 2003)

6

Reaction of wages to imported inflationReaction of wages to imported inflation

1999 2000 2001 2002 AVERAGE 99 – 02

NEGOTIATED

WAGES

(GROSS

EARNINGS)

2.2

(2.3)

2.2

(2.4)

2.6

(3.0)

2.7

(3.3)

2.4

(2.8)

HICP 1.1 2.1 2.3 2.3 2

REAL

NEGOTIATED

WAGE

INCREASE

1.1 0.1 0.3 0.4 0.4

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A simple model of the policy mix (1)A simple model of the policy mix (1)

Start with the quantity theory of money Start with the quantity theory of money MV = PYMV = PY

In rates of change (ignore v)In rates of change (ignore v)m = p+ym = p+y

At the same timeAt the same timey = e+y = e+ππ

(where (where ππ is productivity growth) is productivity growth)

SoSoe = m-p-e = m-p-ππ

What does this imply?What does this imply?

Together, the central bank (m) and the social partners (p) Together, the central bank (m) and the social partners (p) determine the rate of employment growth (if productivity is determine the rate of employment growth (if productivity is taken to be exogenous)taken to be exogenous)

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Simple model (2): The NAIRU frameworkSimple model (2): The NAIRU framework

In the standard NAIRU framework, p is determined by the In the standard NAIRU framework, p is determined by the rate of unemployment:rate of unemployment:

p = p* when u = NAIRUp = p* when u = NAIRU

NAIRU is set by national labour market institutionsNAIRU is set by national labour market institutions-> policy recommendation: deregulate labour (and product) -> policy recommendation: deregulate labour (and product)

markets to lower NAIRUmarkets to lower NAIRU

But what if p becomes a policy variable?But what if p becomes a policy variable?

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Simple model (3): Wage policySimple model (3): Wage policy

Suppose that, independently of u, we stipulate:Suppose that, independently of u, we stipulate:

w = w = ππ + + p*p*

In the medium term this would stabilise (domestic) p at p* subject In the medium term this would stabilise (domestic) p at p* subject to W/Y remaining constantto W/Y remaining constant

Conclusions:Conclusions:

Wage and price setters can, in theory, render the NAIRU Wage and price setters can, in theory, render the NAIRU indeterminateindeterminate

The rate of employment growth can be determined by a The rate of employment growth can be determined by a coordinated policy, coordinated policy, to the extentto the extent that m and p are under that m and p are under controlcontrol

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Simple model (4): Wage policy in a monetary unionSimple model (4): Wage policy in a monetary union

Productivity rates differ – not a problemProductivity rates differ – not a problem

wwaa = π = πaa + p* , w + p* , wbb + π + π b b + p*…… w + p*…… wnn + π + π n n + p* = w + p* = wCACA = π = π CA CA + p* + p*

Inflation rates differ – a problemInflation rates differ – a problem

Some inflation differentials justified, others notSome inflation differentials justified, others not

So target inflation rate needs to be set for each MS, to be overall So target inflation rate needs to be set for each MS, to be overall consistent with p*consistent with p*

αwαwaa = π = π a a + p + paa* , βw* , βwbb + π + π b b + p + pbb*……… θw*……… θwnn + π + π n n + p + pnn* = w* = wCACA = π = πCACA + p* + p*CACA

On one hand: more complexOn one hand: more complexOn other: more realisticOn other: more realisticIncorporation of fiscal policy (support for wage policy from national Incorporation of fiscal policy (support for wage policy from national Phillips Curve) -> SGP reformPhillips Curve) -> SGP reform

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Simple model (5): Conclusions for LisbonSimple model (5): Conclusions for Lisbon

Lisbon conclusions called for an ‘appropriate’ macroeconomic Lisbon conclusions called for an ‘appropriate’ macroeconomic policy, employment growth of around 1%, real GDP growth of policy, employment growth of around 1%, real GDP growth of 3% p.a. and price stability.3% p.a. and price stability.

There is only There is only oneone consistent trajectory to achieve this: consistent trajectory to achieve this:

m = 6% (allowing 1% for v)m = 6% (allowing 1% for v)w = 4% w = 4% Π = 2%Π = 2%p* = 2%p* = 2%

This is a realistic strategy/policy for a ten-year periodThis is a realistic strategy/policy for a ten-year period

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From model to reality – a ‘market solution’From model to reality – a ‘market solution’

Will such a trajectory emerge as a ‘spontaneous order’?Will such a trajectory emerge as a ‘spontaneous order’?

It hasn’t, and probably won’tIt hasn’t, and probably won’t

• Fundamental uncertainty, animal spiritsFundamental uncertainty, animal spirits• Foreign, indirect-tax and other short-run influences on price Foreign, indirect-tax and other short-run influences on price

levellevel• Expectations and path dependencyExpectations and path dependency• Wages (and some prices) set monopolisticallyWages (and some prices) set monopolistically

-> need for a coordinated approach-> need for a coordinated approach

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Model to reality: Incomplete control – a fatal flaw?Model to reality: Incomplete control – a fatal flaw?

Central bank cannot control m directlyCentral bank cannot control m directly• Interest-rate policyInterest-rate policy• Emphasis on medium-runEmphasis on medium-run

Social partners cannot control wages directlySocial partners cannot control wages directly• Declining union membership and bargaining coverageDeclining union membership and bargaining coverage• Wage-price linkWage-price link

Doubts about the wage-price linkDoubts about the wage-price link• Shift in national income to capitalShift in national income to capital• Profits explosion (temporary?)Profits explosion (temporary?)

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From model to reality – problems not fatalFrom model to reality – problems not fatal

• Total control of wages is not necessaryTotal control of wages is not necessary

• Actual wage outcomes have been moderate (at high unemployment), Actual wage outcomes have been moderate (at high unemployment),

especially considering low productivityespecially considering low productivity

• Aim is not NAIRU = 0Aim is not NAIRU = 0

• Decline in bargaining coverage is a reversible political choice; also Decline in bargaining coverage is a reversible political choice; also

examples of bargaining centralisation and coordination (ETUC, EMF examples of bargaining centralisation and coordination (ETUC, EMF

etc.)etc.)

• Extent of possible reduction in NAIRU must emerge from experienceExtent of possible reduction in NAIRU must emerge from experience

• Immediate goal = Lisbon employment targetsImmediate goal = Lisbon employment targets

• Testing water, confidence building => MEDTesting water, confidence building => MED

• Flexible, reversible strategy, without Treaty changes, without loss of Flexible, reversible strategy, without Treaty changes, without loss of

actor autonomyactor autonomy

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Model to reality – necessary institutional developmentModel to reality – necessary institutional development

• Coordination organ (MED) already exists in principleCoordination organ (MED) already exists in principle

• But currently weakly institutionalisedBut currently weakly institutionalised

• Bi-annualBi-annual• Very limited timeVery limited time• Discussions not strategic/forward-lookingDiscussions not strategic/forward-looking• Only at EU-level, no articulationOnly at EU-level, no articulation• No external impactNo external impact

Cf. national ‘concertation’ in pre-EMU Member States and ‘social Cf. national ‘concertation’ in pre-EMU Member States and ‘social pacts’pacts’

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From model to reality – reforms of the MEDFrom model to reality – reforms of the MED

• EU-level MED must be developed into an on-going governance EU-level MED must be developed into an on-going governance

instrumentinstrument• More regular meetings (poss. limited to monetary policy and social More regular meetings (poss. limited to monetary policy and social

partners)partners)

• More strategic orientation of debateMore strategic orientation of debate

• Incorporation of external expertise (scenarios)Incorporation of external expertise (scenarios)

• Stronger articulation with national levelStronger articulation with national level

• Need for a ‘voice’ to stabilise expectationsNeed for a ‘voice’ to stabilise expectations

• MEDs must be institutionalised at national levelMEDs must be institutionalised at national level• To determine appropriate wage and fiscal policy stance for each countryTo determine appropriate wage and fiscal policy stance for each country

• To avoid beggar-thy-neighbour policies (real devaluation)To avoid beggar-thy-neighbour policies (real devaluation)

• To underpin EU-level coordination effortsTo underpin EU-level coordination efforts

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Conclusion: a politically feasible, growth-friendly regimeConclusion: a politically feasible, growth-friendly regime

MP: MP: the central bank symmetrically targets medium-run the central bank symmetrically targets medium-run domestic inflation at an appropriate rate (ECB domestic inflation at an appropriate rate (ECB autonomous in defining price stability)autonomous in defining price stability)

Wage policy: Wage policy: a sufficient degree of wage coordination is achieved to a sufficient degree of wage coordination is achieved to keep real wages in line with medium-run productivity keep real wages in line with medium-run productivity growth (social partner autonomy)growth (social partner autonomy)

FP: FP: SGP (not in Treaty) is reformed to be symmetrical with SGP (not in Treaty) is reformed to be symmetrical with the prime aim of ensuring stable debt dynamics and the the prime aim of ensuring stable debt dynamics and the subsidiary aim of ensuring close-to-potential growth at subsidiary aim of ensuring close-to-potential growth at national/regional levelnational/regional level

Coordination: Coordination: An effective, forward-looking and on-going institution to An effective, forward-looking and on-going institution to forecast developments and agree on consistent forecast developments and agree on consistent behaviour by actors (strengthened MED)behaviour by actors (strengthened MED)

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Political feasibility – some remarksPolitical feasibility – some remarks

Requires no Treaty changes, but rather behavioural changesRequires no Treaty changes, but rather behavioural changes

Autonomy of actors is retained, but more cooperative ‘game’ is Autonomy of actors is retained, but more cooperative ‘game’ is possiblepossible

Minimises tensions between ‘goals’ of the UnionMinimises tensions between ‘goals’ of the Union

Does not require abandonment of European social model or Does not require abandonment of European social model or collective bargaining to reduce NAIRU (EUcollective bargaining to reduce NAIRU (EU

Promotes high-road (productivity-oriented) rather than low-road Promotes high-road (productivity-oriented) rather than low-road (cost-reduction) strategies(cost-reduction) strategies

Ensures balanced participation of workers in output growthEnsures balanced participation of workers in output growth

De-dramatises conflicts over SGP/fiscal policyDe-dramatises conflicts over SGP/fiscal policy

Promotes European integration and positive integration of social Promotes European integration and positive integration of social partners in constructive partnershippartners in constructive partnership

Successful tradition of social pacts at national levelSuccessful tradition of social pacts at national level

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Concluding remarkConcluding remark

Reforms for a cooperative macro policy regime are ultimately matter of Reforms for a cooperative macro policy regime are ultimately matter of political will.political will.

Currently the EU devotes about 20 hours to the overall policy mix in the Currently the EU devotes about 20 hours to the overall policy mix in the MED – a year! MED – a year!

We need to ‘invest’ also in this area if ‘Lisbon’ is to be successfulWe need to ‘invest’ also in this area if ‘Lisbon’ is to be successful

Sadly this does not seem to be appreciated by policymakersSadly this does not seem to be appreciated by policymakers

Gramsci: To the ‘pessimism of the intellect’ we must add the ‘optimism Gramsci: To the ‘pessimism of the intellect’ we must add the ‘optimism of the will’of the will’