Improving the macro policy mix by strengthening the Macroeconomic Dialogue

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Improving the macro policy mix by strengthening
the Macroeconomic Dialogue

• Presentation to the ETUC Conference Delivering
  the Lisbon goals The role of macroeconomic
  policymaking
• International trade Union House, Brussels
• 1/2.03.2005

Andrew Watt
awatt
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Structure of the presentation

• Is it broken? Evidence of failure of policy
  coordination and unnecessary output and
  employment losses
• The key importance of the macro policy mix a
  simple theoretical model
• From model to reality some real-world problems
• Policy coordination in an uncertain world the
  coordination potential of a developed MED
• Conclusion a politically feasible,
  growth-friendly policy mix for Lisbon

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Policy conflicts at root of employment problems

• Historically interest rate spikes in response to
  inflationary pressures have been at the cause of
  investment contraction and higher unemployment.
• Capital-stock and hysterisis effects have made
  some of this unemployment structural
• More recently, in 2000 interest rates were raised
  further than necessary in anticipation of higher
  wage claims that did not materialise
• Europe still has not returned to potential growth

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Investment share and unemployment, EU15, 1961-2001
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ECB main refinancing rates, inflation and real
growth, 1999-2002
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Reaction of wages to imported inflation
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A simple model of the policy mix (1)

• Start with the quantity theory of money
• MV PY
• In rates of change (ignore v)
• m py
• At the same time
• y ep
• (where p is productivity growth)
• So
• e m-p-p
• What does this imply?
• Together, the central bank (m) and the social
  partners (p) determine the rate of employment
  growth (if productivity is taken to be exogenous)

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Simple model (2) The NAIRU framework

• In the standard NAIRU framework, p is determined
  by the
• rate of unemployment
• p p when u NAIRU
• NAIRU is set by national labour market
  institutions
• -gt policy recommendation deregulate labour (and
  product) markets to lower NAIRU
• But what if p becomes a policy variable?

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Simple model (3) Wage policy

• Suppose that, independently of u, we stipulate
• w p p
• In the medium term this would stabilise
  (domestic) p at p subject to W/Y remaining
  constant
• Conclusions
• Wage and price setters can, in theory, render the
  NAIRU indeterminate
• The rate of employment growth can be determined
  by a coordinated policy, to the extent that m and
  p are under control

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Simple model (4) Wage policy in a monetary union

• Productivity rates differ not a problem
• wa pa p , wb p b p wn p n p
  wCA p CA p
• Inflation rates differ a problem
• Some inflation differentials justified, others
  not
• So target inflation rate needs to be set for each
  MS, to be overall consistent with p
• awa p a pa , ßwb p b pb ?wn p n
  pn wCA pCA pCA
• On one hand more complex
• On other more realistic
• Incorporation of fiscal policy (support for wage
  policy from national Phillips Curve) -gt SGP reform

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Simple model (5) Conclusions for Lisbon

• Lisbon conclusions called for an appropriate
  macroeconomic policy, employment growth of around
  1, real GDP growth of 3 p.a. and price
  stability.
• There is only one consistent trajectory to
  achieve this
• m 6 (allowing 1 for v)
• w 4
• ? 2
• p 2
• This is a realistic strategy/policy for a
  ten-year period

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From model to reality a market solution

• Will such a trajectory emerge as a spontaneous
  order?
• It hasnt, and probably wont
• Fundamental uncertainty, animal spirits
• Foreign, indirect-tax and other short-run
  influences on price level
• Expectations and path dependency
• Wages (and some prices) set monopolistically
• -gt need for a coordinated approach

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Model to reality Incomplete control a fatal
flaw?

• Central bank cannot control m directly
• Interest-rate policy
• Emphasis on medium-run
• Social partners cannot control wages directly
• Declining union membership and bargaining
  coverage
• Wage-price link
• Doubts about the wage-price link
• Shift in national income to capital
• Profits explosion (temporary?)

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From model to reality problems not fatal

• Total control of wages is not necessary
• Actual wage outcomes have been moderate (at high
  unemployment), especially considering low
  productivity
• Aim is not NAIRU 0
• Decline in bargaining coverage is a reversible
  political choice also examples of bargaining
  centralisation and coordination (ETUC, EMF etc.)
• Extent of possible reduction in NAIRU must emerge
  from experience
• Immediate goal Lisbon employment targets
• Testing water, confidence building gt MED
• Flexible, reversible strategy, without Treaty
  changes, without loss of actor autonomy

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Model to reality necessary institutional
development

• Coordination organ (MED) already exists in
  principle
• But currently weakly institutionalised
• Bi-annual
• Very limited time
• Discussions not strategic/forward-looking
• Only at EU-level, no articulation
• No external impact
• Cf. national concertation in pre-EMU Member
  States and social pacts

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From model to reality reforms of the MED

• EU-level MED must be developed into an on-going
  governance instrument
• More regular meetings (poss. limited to monetary
  policy and social partners)
• More strategic orientation of debate
• Incorporation of external expertise (scenarios)
• Stronger articulation with national level
• Need for a voice to stabilise expectations
• MEDs must be institutionalised at national level
• To determine appropriate wage and fiscal policy
  stance for each country
• To avoid beggar-thy-neighbour policies (real
  devaluation)
• To underpin EU-level coordination efforts

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Conclusion a politically feasible,
growth-friendly regime

• MP the central bank symmetrically targets
  medium-run domestic inflation at an appropriate
  rate (ECB autonomous in defining price stability)
• Wage policy a sufficient degree of wage
  coordination is achieved to keep real wages in
  line with medium-run productivity growth (social
  partner autonomy)
• FP SGP (not in Treaty) is reformed to be
  symmetrical with the prime aim of ensuring stable
  debt dynamics and the subsidiary aim of ensuring
  close-to-potential growth at national/regional
  level
• Coordination An effective, forward-looking and
  on-going institution to forecast developments and
  agree on consistent behaviour by actors
  (strengthened MED)

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Political feasibility some remarks

• Requires no Treaty changes, but rather
  behavioural changes
• Autonomy of actors is retained, but more
  cooperative game is possible
• Minimises tensions between goals of the Union
• Does not require abandonment of European social
  model or collective bargaining to reduce NAIRU
  (EU
• Promotes high-road (productivity-oriented) rather
  than low-road (cost-reduction) strategies
• Ensures balanced participation of workers in
  output growth
• De-dramatises conflicts over SGP/fiscal policy
• Promotes European integration and positive
  integration of social partners in constructive
  partnership
• Successful tradition of social pacts at national
  level

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Concluding remark

• Reforms for a cooperative macro policy regime are
  ultimately matter of political will.
• Currently the EU devotes about 20 hours to the
  overall policy mix in the MED a year!
• We need to invest also in this area if Lisbon
  is to be successful
• Sadly this does not seem to be appreciated by
  policymakers
• Gramsci To the pessimism of the intellect we
  must add the optimism of the will