Improving the macro policy mix by strengthening the Macroeconomic Dialogue

1. 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

2. 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

3. 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

4. Investment share and unemployment, EU15, 1961-2001 Source: European Economy no. 4, 2002: Tables 3, 19, 24, 49: own calculations Note: real interest rates time series not available for EU15.

5. ECB main refinancing rates, inflation and real growth, 1999-2002 Source: ECB Monthly Bulletin February 2002, February 2001, Sept. 2000

6. Reaction of wages to imported inflation (Source: ECB Monthly Bulletin June 2003)

7. A simple model of the policy mix (1) Start with the quantity theory of money MV = PY In rates of change (ignore v) m = p+y At the same time y = e+π (where π is productivity growth) So e = m-p-π 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)

8. 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 -> policy recommendation: deregulate labour (and product) markets to lower NAIRU But what if p becomes a policy variable?

9. Simple model (3): Wage policy Suppose that, independently of u, we stipulate: w = π + 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

10. Simple model (4): Wage policy in a monetary union Productivity rates differ – not a problem wa = πa + p* , wb + π b + p*…… wn + π n + p* = wCA = π 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* αwa = π a + pa* , βwb + π b + pb*……… θwn + π n + pn* = wCA = πCA + p*CA On one hand: more complex On other: more realistic Incorporation of fiscal policy (support for wage policy from national Phillips Curve) -> SGP reform

11. 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% Π = 2% p* = 2% This is a realistic strategy/policy for a ten-year period

12. From model to reality – a ‘market solution’ Will such a trajectory emerge as a ‘spontaneous order’? It hasn’t, and probably won’t • 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 -> need for a coordinated approach

13. 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?)

14. 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 => MED • Flexible, reversible strategy, without Treaty changes, without loss of actor autonomy

15. 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’

16. 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

17. 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)

18. 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

19. 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’