C A Pissarides - London School of Economics 2014 Monetary and Fiscal Policies and the Labour Market in the Eurozone Christopher A Pissarides London School

C A Pissarides - London School of Economics 2014

Monetary and Fiscal Policies and the Labour Market in the Eurozone

Christopher A Pissarides

London School of Economics

and University of Cyprus

VIII IBM Rotating Chair in Studi del Lavoro

Università degli Studi di Milano

5 December 2014

1


The Eurozone crisis

• Many countries in the Eurozone are still suffering from loss of income, slow recovery and growth and high and persistent unemployment

• Does the fault lie with the structure of labour markets or with monetary and fiscal policies that were followed after the recession?

2


Labour markets and single currencies

• The post-Great Recession European crisis started as a debt crisis

• Policies to reduce public debts have exposed weaknesses in European labour markets

• For this reason, the crisis is often presented as a crisis of competitiveness and flexibility

• But it is not: it is a crisis of managing a common currency area when the criteria for optimality fail

3


Labour markets in crisis?

• European labour markets have become inflexible

• Many reformed: UK in the 1980s, Netherlands in early 1990s, Germany in 2002-05, Spain in 2010-11 and Italy now

• Reforms are essential in Europe for reasons other than debt management (e.g., for competitiveness and adaptability)

• Debt management and inflexible labour markets got confused with bad outcomes for each

4


Optimal Currency Area?

• Once the monetary policy tool is removed economic policy becomes more constrained

• OCA requires similar economic structures and business cycles to reduce the risk of different policy requirements

• But the crisis exposed dissimilarities between the members of the Eurozone

5


Automatic stabilizers

• In theory free mobility of labour and capital and/or fiscal transfers could correct the imbalances

• But Europeans are well-off and prefer living in their country of birth – and receiving countries don’t like it either

• When it takes place it affects “wrong” professional groups

• Highly qualified people, unemployed who depend on social transfers remain. Social support is national

6


Fiscal transfers

• Policy-induced fiscal transfers could balance the Eurozone

• But Eurozone does not allow them. Maastricht criteria are supposed to make sure they are not needed

• There has been some relaxation recently, with ESM and various rescue packages, but they are more in the form of loans than transfers

7

C A Pissarides - London School of Economics 2014 8

Fiscal transfers have been critical in countries where monetary union worked

• United States when West opened up: infrastructure was provided with East Coast money

• German unification: East Germany was kick-started with West German money

• In both cases we had political union!


Dissimilarities in the Eurozone

• Recent crisis exposed some unanticipated dissimilarities between members with bad consequences

• Ireland, Spain, Portugal and Cyprus grew very large construction sectors, supported by bank loans

9


Construction employment shares, 2007 (in red: program countries)

NETSLV

GER

BELDEN

MAL

NOR

AUT

EURO ITA

GRE

CZECYP

LAT

SPA0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

10


Implications

• Crisis started in the housing sector – so countries with bigger construction sectors received a bigger shock

• Governments guaranteed banks to avoid bank failures

• Negative impact of the housing shock was reinforced by public debt explosion that forced contractionary fiscal policy

11


Correlation between construction sector size and growth rates

0 1 2 3 4 5 6 7 8 9 1000

02

04

06

08

10

12

14

R² = 0.197477295735625

Average growth rate 2001-07

Co

nst

ruct

ion

sh

are

2007

CYP

EST

12

POR

SPA IRL

LAT


Correlation between construction sector size and growth rates

0 1 2 3 4 5 6 7 8 9 1000

02

04

06

08

10

12

14

R² = 0.3787432511015

Average growth rate 2001-07

Co

nst

ruct

ion

sh

are

2007

CYP

EST

13

LAT


Labour market responses

• With flexible exchange rates, when big negative shock hits exchange rate depreciates

• With fixed exchange rates the only mechanism left is “internal depreciation”, namely, wage reductions

• Unemployment needs to rise substantially to trigger this mechanism – and it did, making the recession worse

14


Unemployment change 2007-2012

GE

MA AU

RO NO LU FR UK SK DE EU EZ LA IT LI CYG

R-5

0

5

10

15

20

25

15


Did recession trigger the right labour market response?

• Nominal and real wages fell everywhere in the periphery

• But only in Greece to a non-trivial degree: 17% fall in real average earnings

16


Real average earnings 2012(2009=100)

country Real average earnings Relative to Germany

Ireland 97.0 94.2

Italy 97.9 94.0

Spain 96.8 95.1

Portugal 90.6 87.9

Greece 82.5 80.1

17


Did wage adjustments bring the right results?

• Biggest failure of the combined programmes of debt reduction and economic restructuring

• Massive fiscal austerity was reinforced by real wage reductions that spilled out to the whole economy

• Classic Keynesian response of labour markets: negative fiscal multipliers reinforced instead of being offset by wage reductions

18


Why didn’t wage reductions work?

• For standard Keynesian reasons: deflation does not get a country out of a recession, especially one with large debts

• Wage and pension reductions accompanied by a fall in government spending, tax rises and dysfunctional (home-biased) banks reduce aggregate demand catastrophically

• The real value of debt rises; further spending cuts are introduced to reduce the debt to GDP ratio; deflation gets worse

• A vicious circle that leads to more debt and unemployment

19


Labour markets at fault?

• Inflexible labour markets are not the reason for the Keynesian response

• Ireland has flexible labour markets: its aggregates are similar to other countries hit by the construction shock

• The key reason for Europe’s labour markets not working is the deflationary shock following the debt crisis

• Compare Ireland (flexible labour markets) with Spain (inflexible labour markets)

20


GDP per head2007=100

2007 2008 2009 2010 2011 2012 201375

80

85

90

95

100

105

Ireland Spain

21


Employment rates2007=100

2007 2008 2009 2010 2011 2012 201375

80

85

90

95

100

105

110

Ireland Spain

22


Keynesian lessons

• Debt explosion triggered deflationary fiscal policies

• But debt explosion took place because of recession, so deflationary fiscal policies reinforce economic shock

• Optimal policy response is to find expansionary policies elsewhere to offset the two deflationary shocks

• Structural reforms still needed to raise potential GDP growth but actual GDP growth well below potential

23


Optimal policy responses

• Expansionary monetary policy – move to 2% inflation target

• Fiscal transfers – low-debt countries push budget deficits to Maastricht thresholds

• Debt restructuring and some forgiveness

• Structural reforms

24


The Renzi reforms

• Italy has been the “sick man of Europe” for two decades

• Politics and unstable governments are contributory factors

• With Hollande so ineffective Italy had the chance to take lead role in defending European South against German imposed policies

25


Political and economic reforms

• For this reason the political reforms aimed at delivering more stable governments are welcome

• Twin economic problems

– low potential output growth because of poor institutions

– below potential growth because of debt and austerity

26


Austerity versus reforms

• Italy needs to reduce debt and reform its economy to increase potential growth rate

• Austerity brings immediate unemployment rise; reforms need 3-4 years to have an impact

• UK in 1980s and 90s, Germany in 2000s and more recently Spain had to wait 4 or more years to see impact on potential output

27


Timings

• Looser fiscal policy helps pass the reforms – more money for investments and low unemployment makes it easier to accept reforms that will bring temporary rise in job destruction

• In view of this repayment of debts in arrears should help. Morgan Stanley estimate that it could add 0.5 to 1% to cyclical GDP

• Benefit could be more if it facilitates structural reform

28


Labour markets

• Something is clearly not right in Italian labour market

• Clear evidence of dual structure with adult males main beneficiaries

• Worst in Europe!

29


Youth male unemployment relative to adult men, June 2014 (latest)

NETLA

TG

REAUS

SLKCYP

MAL

DENUSA

FINPO

RNO

RCZR

ROM

SWE

0.00.51.01.52.02.53.03.54.04.55.0

30


Youth female unemployment relative to adult men, 2014

GER

NETIR

EAUS

MAL

FINCYP

SLV LUX

GRE

SLKPO

RPO

LCRO

CZR0.00.51.01.52.02.53.03.54.04.55.0

31


Female employment relative to male, 2011

GRE

CZRPO

LSW

IHUN

POR

AUSUSA

GER

FRADEN

EST0

20

40

60

80

100

120

32


North-South divergence

Per capita GDP, constant prices and PPP, relative to EU average

Germany Italy Spain Portugal Greece

1999 122 111 100 85 81

2012 125 95 95 75 75

33

Italy worst performer since introduction of euro


Labour market reform: ideal

• Ideal scenario is “flexicurity”

• Flexibility in the labour market (limited employment protection, no red tape for hires, well organised apprenticeship system getting same attention as formal education)

• Government takes care of support during income loss due to unemployment

• Renzi reforms move the economy in that direction

34


Government transfers

• Unemployment benefit is extended – positive, government takes on the support role

• But needs to do more – active policies not effective in Italy

• Youth guarantee (Hollande-Merkel initiative) was a good idea but ineffective

• Apprenticeships need to be encouraged more.

35


Minimum wage

• Minimum wage can contribute positively to labour market by removing uncertainty for young people in particular but also all unskilled workers

• But it has to be a reasonable level, say 45-50% of median, and comprehensive

• Italian one is not – applies only for occupations not subject to collective agreements(?)

• Minimum wage should have positive supply effects but not negative demand effects

36


Flexible market?

• Reform of employment protection desperately needed

• Dual structure not good – creates second-class citizens and encourages job rotation with high and more “jumpy” unemployment

• As alternative to current system one where worker accumulates financial benefits with tenure is much better

• Right of appeal to courts unduly delay dismissals

37


Current reforms

• Contain positive elements in the gradual accumulation of financial benefits

• Incentives to eliminating dual structure: introducing some termination costs for fixed-term, reducing ones for open-ended, eliminating social contributions for three years for new open-ended contracts signed in 2015

• Have exemptions that enable the reinstatement of the worker in “disciplinary” dismissals

• The jury is out on the importance of the exceptions; once the courts get involved results are unpredictable

38


Conclusions on labour market reform

• Monetary union needs a flexible labour market: ostensibly, the reasons UK and Sweden did not join in 1999 are the inflexible labour markets of continental Europe (including Germany at that time)

• Many countries, especially in the south, still lack flexibility

• Recent structural reforms are in the right direction but they need time to have a positive impact and they need the cooperation of all social partners.

• The German reforms of 2002-05 tool place in favourable conditions and still had their impact 4 years later

39


Conclusions cont.

• But recent problems in European labour markets not due to inflexibility

• Better macro management needs to go in parallel with structural reforms

40

Documents

C A Pissarides - London School of Economics 2014 Monetary and Fiscal Policies and the Labour Market in the Eurozone Christopher A Pissarides London School