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Wage inflation: a key difference between Europe and the United States
Economists had begun to worry that the famous Phillips curve had disappeared. In the version most commonly used today, it describes a negative relationship between the unemployment rate and changes in the inflation rate. In particular, a fall in unemployment below its structural level – i.e. the rate at which inflation would remain stable (NAIRU: Non-Accelerating Inflation Rate of Unemployment) – should lead to an acceleration in wage inflation. The idea is simple: when the number of applicants is low compared to the number of available jobs, employees can negotiate higher wages.
The structural rate of unemployment varies over time and between different countries based on a number of factors, particularly the composition of the population and the unemployment insurance system. For the United States, the Federal Reserve estimates that it is currently between 5.0% and 5.2%. The latest employment report, released on 6 November, is particularly encouraging in this respect. It records 271,000 new jobs in October, significantly exceeding market expectations. The unemployment rate fell to 5.0% and, finally, there were clear signs of an acceleration in wage growth, with a 2.5% increase since October 2014. This should allow the US economy to return to 2% inflation (based on consumer prices) in the second half of 2016, since consumer prices generally respond with a lag. Conditions therefore appear to fall into place for the first increase in policy rates since 2004 in the United States and the market now considers the likelihood of a hike in December to be well over 50%. Postponement to 2016 obviously remains a possibility, particularly if November's figures fail to back up the positive surprise in October.
In the euro zone, on the other hand, there are few signs of wage inflation for the time being. The euro zone's overall unemployment rate has fallen from a peak of 12% in 2013 to 10.8% in September 2015. In any case, it remains well above its structural level, which the OECD estimates at around 9.5%. In other words, the euro zone has only managed to make up half of the shortfall compared with the structural unemployment rate and the output gap remains high. These aggregated figures of course conceal major differences between countries. Germany, for instance, is close to full employment with wage inflation of 2.8% in the second quarter. On the other hand, excess capacity remains high in France, Italy and Spain. Although Spain has reduced its unemployment rate by five percentage points, it remains at a level of 22%. It is difficult to see how wages will increase substantially in those countries at this stage.
This does not make life any easier for the European Central Bank, whose objective is to achieve inflation of close to 2% in the medium term. Although underlying factors related to oil price movements over the course of the last year are likely to push up inflation mechanically towards the end of 2015 and early 2016, we will in all likelihood remain well below the 2% target in 2016. In fact, medium-term inflation forecasts have tended to get revised downwards recently. The ECB is therefore likely to announce additional measures at its December meeting.
BGL BNP Paribas
Published on paperjam.lu (in French) on 19 November 2015