ECB’s de Cos: Need Unexpectedly Strong Wage Growth for Upside Mid-Term Inflation Surprise
22 December 2021
By David Barwick – FRANKFURT (Econostream) – Stronger-than-expected medium-term inflation would probably require a more robust evolution of wages than the evidence so far presages, European Central Bank Governing Council member Pablo Hernández de Cos said Wednesday.
In an interview with Politico, de Cos, who heads Banco de España, was asked why his interpretation of the ECB’s need for policy flexibility focused on the possibility of more rather than less accommodation despite upside inflation risks. He reiterated the ECB’s willingness to move in ‘either direction’ and suggested that the issue came down ‘to the question of the extent to which risks to inflation are on the upside.’
An upside medium-term inflation surprise was ‘very difficult to imagine’ absent ‘relatively strong wage growth’, he said. The inflation forecast includes ‘very mild second-round effects on wages’ while also foreseeing wage growth over the forecast period of more than 3% on average, he said.
‘In order to justify such a high number, one has to incorporate some higher elasticities of wages to slack’, he said. ‘This is something that has yet to materialise. In some sense, there is a kind of positive judgement on wages that we are not calling second-round effects but are embedded in the forecasts.’
The mild macroeconomic scenario sees 2024 HICP at 2%, with the severe counterpart at 1.3%, he said, possibly to imply that there was more room for a downside surprise.
The range of potential outcomes was ‘a good example of the high level of uncertainty that we are facing’, he said. ‘So overall I think we have made a very balanced decision.’
De Cos stressed that while the updated forecasts showed ‘further convergence’ towards price stability, the 2024 projection of 1.8% meant that ‘not only this but other indicators for the medium-term inflation outlook for the euro area point to the fact that we are still below our target.’
This, along with elevated uncertainty, argued for flexibility and optionality, he said. This was reflected, he said, in the willingness of the Governing Council to ‘consider restarting net asset purchases’, in the state-dependence of forward guidance and in the fact that ‘the duration of the APP is open-ended and very much linked to the lift-off in rates.’
A decision to restart asset purchases under the pandemic emergency purchase programme ‘would be conditional on the evolution of the pandemic and its impact on our economies and the inflation outlook’, he said. This is understood to include the ‘transition out of the pandemic.’
‘So we will have to analyse at each point in time whether the pandemic is affecting our economy and the inflation outlook to an extent that might justify this reopening of net purchases under the PEPP’, he said. ‘I think that this is an option that is on the table and that will be executed if needed.’
How the Omicron variant of the coronavirus would affect inflation ‘is not so straightforward’, de Cos said. ‘Omicron will have a contractionary impact on demand and this could actually translate into lower prices. But there will be also an impact on supply and this goes in the opposite direction.’
The new variant ‘has been taken into account at least partially, although the Eurosystem staff did not know how the Omicron variant would evolve when completing the forecast (late November)’, he said.
Restrictions being introduced in response would likely have some economic impact, he said, although economic agents are now accustomed to adjusting. ‘This means that the same level of restrictions today, as compared with the level observed a year and a half ago, generates a lower impact on growth.’