Earlier this month, European Central Bank President Jean-Claude Trichet said that euro-zone inflation risks were “broadly balanced.” Maybe a glance at last week’s data on the currency bloc’s hourly labor costs will change his mind (…okay, probably not).
Eurostat reported that hourly labor costs in the euro zone rose 0.8%, the lowest rate of increase on record since the agency started keeping track in 2000. What’s the importance of hourly labor costs?
Headline inflation numbers tend to be relatively noisy, bouncing around with surges and dips in the price of commodities. But wages and salaries change slowly. Many economists believe they more accurately determine whether inflationary pressures are becoming embedded in prices.
From this perspective, the current meager increases in labor costs suggest that inflation is very far from being a problem; instead, outright deflation may be the clear and present danger.
The ECB, it’s true, appears to give unusual weight to commodity prices when setting interest rates. In fact, soaring commodity prices were behind what has been regarded as one of the ECB’s more ill-timed monetary-policy decisions: its move in July 2008 to raise interest rates 0.25%, just months before the financial crisis exploded.
You might argue that falling labor costs show the EU economy is adjusting to the shock of the financial crisis. Weaker euro-zone economies and those countries that peg their currencies to the euro need to see their labor costs fall, after enjoying a decade of wage growth fueled by easy credit. Without the ability or desire to devalue their currencies, lower wages are essential to erasing competitiveness gaps with the core euro-zone economies: Germany, France, the Netherlands, Austria and Finland.
But here there’s also reason to worry. Latvia, a country that desperately needs to become more competitive, saw its hourly labor costs fall just 0.5%, while the Netherlands registered a 1.3% drop in labor costs. Finland’s labor costs fell 0.7%. And Germany’s labor costs rose just 0.5%. Greece was the only weak euro-zone that saw labor costs fall significantly (-6.6%).