Bundesbank lessons for today’s central bankers

The discussion around high inflation sometimes focuses on assigning blame for the problem to either irresponsible workers who make unreasonable salary expectations or greedy firms that raise prices. However, despite the fact that a lot of individuals take pleasure in playing the blame game, we really need to focus on finding a solution to the issue.

All of these economies are going through an unhealthy wage-price dynamic due to the fact that core inflation is remaining stubbornly close to 5% in the United States, the eurozone, and the United Kingdom, where it is much higher than in the other economies. Workers have been emboldened to fight for their current pay rates as a direct result of firms’ decision to raise prices, which has led to an even greater incentive for companies to do so. Even while it is not precisely a wage-price spiral, it is a destructive ratchet nonetheless.

On opposite sides of the Atlantic, people have come up with slightly different explanations for what caused the ratchet. In the United States, a new study written by Ben Bernanke, a former chair of the Federal Reserve, and Olivier Blanchard, a former chief economist of the International Monetary Fund, makes the compelling case that the start of the inflationary process in 2021 was caused by a shock to the costs of gasoline and food.

in addition to high levels of expenditure on other products. In a world of high demand, low unemployment, and record vacancies, it later spread to various types of goods and services, as well as to pay, as everyone tried to alleviate as much of their own personal suffering as possible.

As a result of the rise in wholesale petrol prices over the past year, initial attention in Europe was focused even more intently on the energy sector. This insured that the majority of workers’ real salaries would see severe decreases as a result. Despite this, their increases in nominal compensation contributed to a general upward trend in prices throughout entire economies, so making inflation more widespread. This indicates that declining real earnings do not necessary serve as a protection against a wage-price ratchet if the first shock is sufficient in magnitude.

Therefore, there is little question on either side of the Atlantic that the most recent levels of wage rises — 6% in the United States, 4.6% in the eurozone, and 6.5% in the United Kingdom — are not consistent with reducing inflation down to 2%, which is the aim of all major central banks. If inflation is to be reined in, these growth rates will need to slow down significantly.

Central bankers have been giving their opinions over the past few days regarding how they believe the conflict that exists between wages and prices will be addressed. The chair of the Federal Reserve, Jay Powell, stated that the pace of wage growth was slowing from “highly elevated” levels a year ago. In light of the recent decline in headline inflation rates, he added, “we want to see that process continue gradually,” implying that the passage of time was a powerful medicine.

Isabel Schnabel, a member of the executive board of the European Central Bank, expressed her belief that some of the catch-up in wages could be “absorbed, to a large extent, by firms’ profit margins, thus breaking the vicious circle between wages and prices.” Nevertheless, she cautioned that if wage increases went too far, this would result in more inflation.

These are some of the outcomes that could occur. After prices and salaries have gotten entangled, however, it is difficult to disentangle them. And as Professor Wendy Carlin from University College London writes, everyone should take attention of what the Bundesbank, that bastion of orthodoxy, said in its 1973 annual report after the Opec oil shock. This can be found in the report.

After “a year of hard struggle for more price stability,” the report stated that the success of each nation depends on “whether it is made easier or more difficult to pass on the higher prices [of oil].” The report was released after “a year of hard struggle for more price stability.” Confronted with the possibility of a wage price spiral, or, as the Bundesbank described it, “the domestic struggle for the distribution of the national income,” the bank stated that its objective was “to restrict the scope for passing on the higher prices as far as possible from the monetary angle.” It won the war against inflation in the 1970s thanks to blunt words and forceful action, but it did so nearly entirely on its own.

As a result, it is of little consequence as to what brought about the sudden increase in pricing. However, before lifting their foot off the brake, central banks need to be absolutely convinced that they have eliminated the wage-price ratchets that have been plaguing their economies. Even if it turns out that maintaining higher interest rates for a longer period of time is too harsh in hindsight, it will be necessary to do so.


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