[Note: this is a slightly edited ChatGPT translation of an article for the Italian daily Domani]

Last week’s piece of news is the gap that opened between the US central bank, the Fed, and the European and British central banks. Apparently, the three institutions have adopted the same strategy, deciding to leave interest rates unchanged, in the face of falling inflation and a slowdown in the economy. But, for central banks, what you say is just as important as what you do; and while the Fed has announced that in the coming months (barring surprises, of course) it will begin to loosen the reins, reducing its interest rate, the Bank of England and the ECB have refused to announce cuts anytime soon.

To understand why the ECB remains hawkish, one can read  the interview with  the Financial Times  of the governor of the Central Bank of Belgium, Pierre Wunsch, one of the hardliners within the ECB Council. Wunsch argues that, while inflation data is good (it is also worth noting that, as many have been saying for months, inflation continues to fall faster than forecasters expect), wage dynamics are a cause for concern. In the Eurozone, in fact, these rose by 5.3% in the third quarter of 2023, the highest pace in the last ten years. The Belgian Governor mentions the risk that this increase in wages will weigh on the costs of companies, inducing them to raise prices and triggering further wage demands; As long as wage growth is not under control, Wunsch concludes, the brakes must be kept on. Once again, the restrictive stance is justified by the risk of a price-wage spiral, that so far never materialized, despite having been evoked by the partisans of rate increases since 2021. Those who, like Wunsch, fear the wage-price spiral, cite the experience of the 1970s, when the wage surge had effectively fueled progressively out-of-control inflation. The comparison seems apt at first glance, given that in both cases it was an external shock (energy) that triggered the price increase. But, in fact, it was not necessary to wait for inflation to fall to understand that the risk of a wage-price spiral was overestimated and used by many as an instrument. Compared to the 1970s, in fact, many things have changed. I talk about this in detail  in Oltre le Banche Centrali, recently published by Luiss University Press (in Italian): Automatic indexation mechanisms have been abolished, the bargaining power of trade unions has greatly diminished and, in general, the precarization of work has reduced the ability of workers to carry out their demands. For these and other reasons, the correlation between prices and wages has been greatly reduced over three decades.

But the 1970s are actually the exception, not the norm. A recent study by researchers at the International Monetary Fund looks at historical experience and shows that, in the past, inflationary flare-ups have generally been followed with a delay by wages. These tend to change more slowly than prices, so that an increase in inflation is not followed by an immediate adjustment in wages and initially there is a reduction in the real wage (the wage adjusted for the cost of living). When, in the medium term, wages finally catch up with prices, the real wage returns to the equilibrium level, aligned with productivity growth. If the same thing were to happen at this juncture, the IMF researchers believe, we should not only expect, but actually hope for nominal wage growth to continue to be strong for some time in the future, now that inflation has returned to reasonable levels: looking at the data published by Eurostat, we observe that for the eurozone, prices increased by 18.5% from the third quarter of 2020 to the third quarter of 2023,  while wage growth stopped at 10.5%. Real wages, therefore, the measure of purchasing power, fell by 8.2%. Italy stands out: it has seen a similar evolution of prices (+18.9%), but an almost stagnation of wages (+5.8%), with the result that purchasing power has collapsed by 13%.

Things are worse than these numbers show. First, for convergence to be considered accomplished, real wages will have to increase beyond the 2021 levels. In countries where productivity has grown in recent years, the new equilibrium level of real wages will be higher. Second, even when wages have realigned with productivity growth, there will remain a gap to fill. During the current transition period, when real wages are below the equilibrium level, workers are enduring a loss of income that will not be compensated for (unless the real wage grows more than productivity for some time). From this point of view, therefore, it is important not only that the gap between prices and wages is closed, but that this happens as quickly as possible.

In short, contrary to what many (more or less in good faith) claim, the fact that at the moment wages are growing more than prices is not the beginning of a dangerous wage-price spiral and the indicator of a return of inflation; rather, it is the foreseeable second phase of a process of rebalancing that, as the IMF researchers point out, is not only normal but also necessary.

The conclusion deserves to be emphasized as clearly as possible: if the ECB or national governments tried to limit wage growth with restrictive policies, they would not only act against the interests of those who paid the highest price for the inflationary shock. But, in a self-defeating way, they would prevent the adjustment from being completed and delay putting once and for all the inflationary shock behind us.