Blog Post

German wages, the Phillips curve and migration in the euro area

This post studies why wages in Germany have not borne strong increases despite a relatively strong labour market. I list four reasons why announcing the death of the Phillips curve – the negative relationship between unemployment and wage growth – is premature in Germany. One of the reasons I report is substantial immigration from the rest of the EU.

By: Date: November 29, 2017 Topic: European Macroeconomics & Governance

An important debate in the blogosphere concerns the possible death of the Philipps curve i.e. the empirical relationship between inflation or wage growth on the one hand and the amount of slack in the labour market on the other hand. European Central Bank president Mario Draghi has recently confirmed his conviction that euro-area inflation rates will pick up as the slack in the labour markets closes. He expressed confidence that with sufficient patience, we will see an increase in inflation.

In this blog post, I analyse one important aspect of the debate for the euro area: wage developments in Germany. If Germany’s Phillips curve was dead and wages remained low, it would have far-reaching implications for inflation in the euro area as a whole. I find that the Phillips curve correlation is weaker after the crisis but is still present.  Recent wage demands in collective bargaining and wage settlements have increased, while the substantial increase in immigration from the EU towards Germany could have contributed to the more muted recent wage rise. Germany already has a higher participation rate than the euro-area average, suggesting that labour force increases may be more muted. As the slack falls, wages should increase.

Germany’s wage developments have continuously outperformed those of the rest of the euro area since 2010               

Germany’s wage developments have continuously outperformed those of the euro area since 2010, while the opposite was true before 2010. The same is also roughly true for real wages. Yet, wage developments have still been low and disappointing in Germany since 2010, hardly surpassing the 2% inflation goal of the ECB. Since there is productivity growth, German inflation rates have been mostly below 2% since the beginning of the 2009 crisis. And of course, arithmetic rules require German inflation to be well above 2% if the euro area is to achieve a 2% inflation average, as several countries will still need to run lower inflation rates to regain relative price competitiveness.

Reasons why declaring the Phillips curve in Germany dead may be premature

If the Phillips curve was strong and alive, shouldn’t we see much higher inflation rates in Germany, given that Germany’s unemployment rate is only around 3.7%? This question is particularly relevant in the euro area as higher inflation rates in Germany facilitate relative price adjustment between Germany, France and Italy. If Germany runs an inflation rate of below 2%, some southern European countries may have to run lower inflation rates in order to adjust their level of competitiveness relative to Germany. Will the break-down in Germany’s Phillips curve lead to deflation in the South?

Here are four reasons why this worry is, at least, exaggerated.

For a start, Germany’s Phillips curve seems to continue to exist as Figure 2 shows. Nominal wage growth is negatively correlated with the unemployment rate. The relationship also holds for the more recent period since the beginning of the crisis, though it is less evident (i.e. the fit is lower). This suggests that as the unemployment rate falls further, nominal wage growth should increase. This, in turn, should eventually push companies to also increase prices. The Phillips curve also exists for real wage growth, which suggests that German workers also see their real income increase.

Figure 2: Nominal wage growth Phillips curve, 1999Q1-2017Q3

Source: Bruegel, Statistisches Bundesamt, Eurostat

Second, the tighter labour market seems to gradually also lead to stronger increases in wage agreements in collective wage bargaining. One obvious example is the recent demand by the IG Metall union to increase wages by 6%, combined with demands for more flexibility on working hours. The increased demands are also starting to be visible in the economy-wide collectively agreed monthly earnings in Germany. As can be seen in Figure 3, in the second quarter of 2017 these have reached the highest increase since 2011.

Third, there has been one major labour supply effect that may have dampened short-term wage increases for some time: immigration. A basic mechanism for adjustment to wage differences and unemployment differences in a monetary union should be immigration. Accordingly, one would expect immigration in Germany to have increased since the start of the crisis, as the German labour market was doing relatively well.

The table below shows that total net immigration from the EU into Germany has increased from negative numbers in 2008 to well above 300,000 in 2015. Gross immigration has more than doubled and reached more than 900,000. We are focusing here on intra-EU migration as it is for a great part directly linked to the labour market, while immigration numbers from outside the EU are heavily influenced by motives other than access to the labour market. Immigrants coming for family reunification or refugees and asylum seekers are often not integrated into the labour market immediately.

We also look at immigration from the entire EU, as the EU has free movement of labour i.e. labour mobility can occur from any EU country and is not solely restricted to the euro area. In fact, it is well established that often workers from eastern Europe’s non-euro-area countries move to different countries in the ‘West’ but then are more quick to move away. For example, a Romanian may have moved in the housing boom to Spain before the crisis only to now work on a German construction side. The break-down across countries shows that much of the increase has originated from Poland, Romania and Bulgaria. Yet, the numbers of immigrants with Italian, Greek and Spanish nationality have also risen substantially.

The numbers therefore suggest that a still somewhat slow wage growth in Germany can at least in part be attributed to immigration.

Fourth, labour force participation in Germany is already quite high and certainly significantly higher than the euro-area average. That suggests that further labour supply increases resulting from rising participation may be more muted in Germany than elsewhere. In turn, this could lead to higher inflation rates in Germany than elsewhere.

In conclusion, German wage and inflation developments are still quite low but there are encouraging signs that wage growth will pick up and, with it, inflation rates. The slack in the German economy is certainly lower than elsewhere in the euro area. Immigration to Germany has played part of the role of adjustment to unemployment rates elsewhere, thereby also reducing the slack there and providing the ground for new wage increases. Overall, however, the adjustment is slow and wage settlements in Germany are certainly rather cautious. Yet, the Phillips curve is still alive and wages do adjust.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article Download PDF More on this topic

Policy Contribution

Equity finance and capital market integration in Europe

Facilitating the financing of European companies through external equity is a central ambition of European Union financial regulation, including in the European Commission’s capital markets union agenda. Against this background, the authors examine the present use of external equity by EU companies, the roles of listings on public markets, and the regulatory impediments in national laws. They assess to what extent EU market integration has overcome the crucial obstacle of shallow local capital markets.

By: Inês Goncalves Raposo and Alexander Lehmann Topic: Finance & Financial Regulation Date: January 17, 2019
Read article More by this author

Blog Post

What 2019 could bring: A look inside the crystal ball

Economic performance prospects in Europe, the US and Asia in 2019. We start off by reviewing commentaries and predictions about the euro zone, which many commentators expect to perform below potential as uncertainties continue to dampen a still robust recovery.

By: Michael Baltensperger Topic: European Macroeconomics & Governance, Global Economics & Governance Date: January 14, 2019
Read article More by this author

Podcast

Podcast

Director’s cut: Wrapping up 2018

With 2018 drawing to a close, and the dawn of 2019 imminent, Bruegel's scholars reflect on the economic policy developments we can expect in the new year – one that brings with it the additional uncertainty of European elections.

By: The Sound of Economics Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Date: December 20, 2018
Read article Download PDF More on this topic

Policy Contribution

The euro as an international currency

Is a more important international role for the euro worth pursuing? What measures would achieve this result, if it is worth pursuing?

By: Konstantinos Efstathiou and Francesco Papadia Topic: European Macroeconomics & Governance Date: December 18, 2018
Read article Download PDF More on this topic More by this author

Policy Contribution

Forecast errors and monetary policy normalisation in the euro area

What did we learn from the recent monetary policy normalisation experiences of Sweden, the United States and the United Kingdom? Zsolt Darvas consider the lessons and analyse the European Central Bank’s forecasting track record and possible factors that might explain the forecast errors.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 13, 2018
Read article Download PDF More on this topic More by this author

Essay / Lecture

A new statistical system for the European Union

Quality statistics are essential to economic policy. In this essay, Andreas Georgiou demonstrates the existence of fundamental risks inherent in the European Statistical System. He argues that a paradigm shift is necessary and sets out a model that would deliver the quality statistics the European Union needs.

By: Andreas Georgiou Topic: European Macroeconomics & Governance Date: December 12, 2018
Read article More on this topic More by this author

Opinion

Immigration: The doors of perception

Surveys show that people systematically overestimate the share of foreign-born citizens among resident populations. Aligning people's perceptions with reality is vital to the betterment of public debate and proposed policies.

By: Inês Goncalves Raposo Topic: Global Economics & Governance Date: December 12, 2018
Read article More on this topic More by this author

Blog Post

ECB’s huge forecasting errors undermine credibility of current forecasts

In the past five years ECB forecasts have proven to be systematically incorrect: core inflation remained broadly stable at 1% despite the stubbornly predicted increase, while the unemployment rate fell faster than predicted. Such forecast errors, which are also inconsistent with each other, raise serious doubts about the reliability of the ECB’s current forecast of accelerating core inflation and necessitates a reflection on the inflation aim of the ECB.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 6, 2018
Read article More on this topic More by this author

Opinion

The great macro divergence

Global growth is expected to continue in 2019 and 2020, albeit at a slower pace. Forecasters are notoriously bad, however, at spotting macroeconomic turning points and the road ahead is hard to read. Potential obstacles abound.

By: Jean Pisani-Ferry Topic: Global Economics & Governance Date: December 5, 2018
Read article More on this topic

Blog Post

Youth unemployment: Common problem, different solutions?

Youth unemployment is a major obstacle to the Middle East and North Africa (MENA) region’s human and economic development. In this blog post, Uri Dadush and Maria Demertzis go into the factors behind the its surge.

By: Uri Dadush and Maria Demertzis Topic: Global Economics & Governance Date: November 29, 2018
Read article Download PDF

External Publication

European Parliament

How to provide liquidity to banks after resolution in Europe’s banking union

Banks deemed to be failing or likely to fail in the banking union are either put into insolvency/liquidation or enter a resolution scheme to protect the public interest. After resolution but before full market confidence is restored, the liquidity needs of resolved banks might exceed what can be met through regular monetary policy operations or emergency liquidity assistance. All liquidity needs that emerge must be met for resolution to be a success. In the euro area, this can only be done credibly for systemically important banks by the central bank.

By: Maria Demertzis, Inês Goncalves Raposo, Pia Hüttl and Guntram B. Wolff Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: November 22, 2018
Read article Download PDF

Policy Contribution

European Parliament

A monetary policy framework for the European Central Bank to deal with uncertainty

In this Policy Contribution prepared for the European Parliament’s Committee on Economic and Monetary Affairs (ECON) as an input to the Monetary Dialogue, the authors review the emerging challenges to central banks, and propose an updated definition of price stability and an adequately refined monetary policy framework.

By: Grégory Claeys, Maria Demertzis and Jan Mazza Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: November 22, 2018
Load more posts