More aggressive anti-inflation policies by central banks can boost employment by scaring trade unions away from making excessively high wage demands, a research report published by the European Central Bank argues.
If demands by a handful of trade unions drive wages in an economy, then it is possible for a central bank to keep pay levels down by raising interest rates in response to excess wages, delivering a punitive short-term bout of unemployment.
This would teach unions to moderate wage demands, boosting employment in the longer run, says the paper's author, Stefano Gnocchi from the Universitat Pompeu Fabra in Barcelona. "Tougher inflation stabilization policies punish wage increases with a harsher contraction of aggregate labor demand, giving unions the incentive to restrain real wages.
In this context, the central bank can raise long-run employment by implementing more aggressive stabilization policies," he said. In October the ECB stepped up its calls for unions to keep a lid on wage demands as the euro zone economy enjoys its best growth this decade.
But it has stopped short of suggesting a direct link between wage deals and interest rates. Research published by the ECB does not represent the official stance of the central bank. When the number of unions increases, then the individual impact of each union's wage deal on inflation lessens, making it harder for the central bank to impose discipline, the research said.
But more fragmented labour markets allow wages to be set more efficiently, boosting employment anyhow, Gnocchi said his mathematical model showed. Most euro zone countries have wages set on an industry-wide basis, according to data from the Organisation for Economic Cooperation and Development in Gnocchi's article.
In a related piece of research conducted by the ECB and the US Federal Reserve, it was shown that countries with more unionised workers report more wage rises of at least the rate of inflation, independent of the strength of labour laws and links between business and unions.
The paper looked at more than 31 million wage changes in the United States and the 16 largest west European economies between 1972 and 2003, to see whether wages changed flexibly or instead were "sticky" and rarely fell in real or nominal terms. "Countries with a greater union density have a greater incidence of downward real wage rigidity," the research concluded. By contrast, the strength of labour laws and links between business, government and unions did not affect wages.