No more talk of wage-price spirals please, Mr King!
I won’t spend long dwelling on this morning’s downgrading of the Bank of England growth forecast, as outlined in its latest Inflation Report. The Bank presents its GDP projection as a fan chart, showing various levels of possible growth with various levels of probability, so it’s hard to draw clear statistics, although the Press Association has had a go. According to the Guardian, PA are saying that the Bank has downgraded its projections for GDP in 2011 to around 1.7% from around 2.0% in its February Inflation Report. GDP in 2012 is expected to come in at around 2.2%, from just under 3% previously forecast.
This will surprise no-one. Embark on a massive package of spending cuts, put hundreds of thousands of public sector workers out of a job, increase VAT and fail to develop a meaningful growth strategy and its hard to expect anything else. Only George Osborne and Nick Clegg don’t seem to get it. It’s worth noting, however, that the Bank’s forecasts, on growth and inflation, factor in an interest rate rise in the third quarter of this year. If growth really is sluggish, it might need to think again about that. The Bank Governor, Mervyn King, warns that CPI inflation may go as high as 5% during this year, but he has been clear that high inflation is due to imported commodity prices and increased VAT. A rise in base rates would make no difference to those factors, whilst undermining growth still further.
I’m a little concerned that in his opening remarks to the press conference introducing the Inflation Report, Mervyn King said:
“An important question for the MPC is whether the current high rate of inflation will affect its medium-term level. There is a risk that continuing high rates of inflation will push up on inflation expectations, or lead to some resistance to the erosion of real take-home pay. Either of these mechanisms could put upward pressure on wages and prices looking ahead, and imply that inflation will not fall back as sharply when the temporary effects of higher VAT, energy and import prices come to an end.”
To be fair to Mr King, he went on to say that there are other influences on wages and prices that are pushing in the opposite direction. But it’s hard to see what the point of this comment was. It’s as if the Bank can’t talk about inflation without issuing a pay-related health warning. Yet as Mervyn King himself has recognised, rising wages are the last of our fears. In his well-reported Newcastle speech in January, the Bank Governor pointed out that in 2011 real wages are likely to be no higher than they were in 2005. He added that one has to go back to the 1920s to find a time when real wages fell over a period of six years.
Nobody wants a wage-price spiral, but the real issue is that stagnating wages have contributed to the economic crisis and increasing wage levels have a role to play in getting us out of it. The Global Wage Report 2010-11, published by the International Labour Organisation, has this to say:
“… declining wages in periods of crisis may actually lead to a spiral of falling aggregate demand and price deflation, rather than to a quicker economic recovery. In fact, a number of observers have established links between the long-term decline in the wage share, the increase in wage inequality and the global economic crisis… A group of distinguished experts led by Jean-Paul Fitoussi and Joseph Stiglitz considered that the crisis had its structural roots in the decline in aggregate demand that preceded the crisis and which was due to changes in income distribution… Looking forward, the macroeconomic link between wages and aggregate demand also indicates that the pace of the recovery will depend, at leas partly, on the extent to which households are able to use their wages to consume whatever the global economy produces.”
We all know that, if a phrase gets repeated often enough, it is likely to stick in the public consciousness. So no more talk of the threat of wages please, Mr King. Real, but not excessive, wage increases are part of the solution, not part of the problem.