Balazs Koranyi, Michael Nienaber

FRANKFURT (Reuters – In the last week, conservative central bankers have been focusing on the dangers of spiralling wages inflation in the euro area.

High inflation, even temporary, is a concern. Firms will likely increase wages to keep inflation going, increasing demand and perpetuating it.

This isn’t an unreasonable fear at first glance. Inflation has reached unexpected heights due to wage-price increases, most notable in the 1970s.

It could keep inflation at 2%, which is the target of the European Central Bank. This would force the bank to tighten its policy following years of unimaginable stimulus.

Jens Weidmann, President of Bundesbank, stated that companies’ complaints regarding labour shortages had increased substantially, especially in Germany but also with our European neighbors.

“In the future such tensions in the labour market could make it easier to employee and trade unions push for noticeably higher wages.”

LITTLE EvidENCE

However, there are very few facts, including actual wages, labour market trends, or demands from unions, that support such fears.

While wage growth has remained flat, data have been tampered with by the pandemic. It is difficult to determine how healthy the labor market really is due to the numerous furloughs and swings in employment caused by the economic shut-down and opening.

Union demands for next year’s salary have been disappointing so far.

Some industries have a significant shortage in skills, such as the construction industry. Germany’s construction industry saw a 3.4% growth, while retail experienced a 2.2% increase. However, inflation is expected to remain above 2% in the next year so this increase in real terms is still modest.

In this regard, Europe is in sharp contrast to the U.S. U.S. labor costs rose by more than 50% since 2001. Companies increased their wages and benefits in an effort to meet a worker shortage. It also points out that there has been an increase in inflation.

The majority of wage agreements in Germany, the most powerful labour market in the bloc, are in the 1.5%-2.5% range. This may be too low for inflation to maintain at 2% according to economists.

This is due to unions prioritising benefits other than wages, from increased leisure time and job security.

“The wage agreements that we’ve seen so far this year do not indicate that wage developments are currently posing an increased risk of inflation in Germany,” Sebastian Dullien, an expert at the IMK economic institute, said.

He said that the current negotiations could be described as being moderate, especially when compared to demands during times prior to the pandemic.

Despite the fact that labour costs rose in the euro area by 2% to 3% before the pandemic began, inflation still fell below the ECB target.

Also, the labour market is still reeling from the effects of the pandemic. There is still a lot of work to do. The employment rate remains below pre-crisis levels, the hours worked is down by 4%, and almost 2.5 million people remain in some form of job retention program.

Some argue even that an increase in wage growth is welcome following the destruction of households by the pandemic.

Fabio Panetta, an ECB member said that “we should not be alarm if there are signs of a single catch-up in wages next Year.” In the medium term, it would be desirable for us to see increases in unit labour prices.

Ironically, it is Germany’s incoming Government that could boost inflation and not the ECB.

The plan to increase the minimum wage from around 25 to 12 euro an hour would push up wages across the board. This move was heavily criticised by the Bundesbank which usually refrains discussing politics.

It stated that the significant increase in the minimum wage would impact the lowest wage brackets significantly and have no negligible spillover effects to the higher wage brackets.

The economy is not healthy. The economy is in crisis. A new pandemic is threatening to hit.

Rapid wage growths may not be possible right now. However, evidence is strongly pointing towards a positive outcome.