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Re-discovering the Phillips curve

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1 October, 2014
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Andor, L. (2014) “Re-discovering the Phillips curve“, VoxEU Organisation, 01 October.

 

Negative real interest rates imply redistribution from savers to debtors. This column, by the EU Commissioner for Employment, Social Affairs and Inclusion, argues that such redistribution would benefit the whole economy. It would strengthen aggregate demand – including investment demand – at time when such a boost is clearly needed.

As a contribution to the EU’s institutional transition, a conference entitled “Labour Economics after the Crisis” took place in Brussels on 18-19 September 2014. The aim was to draw lessons from Europe’s protracted jobs crisis and from the experience of the Barroso II Commission as regards macroeconomic and employment policies.1

My key ‘handover’ message was that Europe needs to re-discover the Phillips Curve and pursue higher inflation if the EU is to make progress towards the 75% employment rate target of the Europe 2020 Strategy.2

The European labour market is currently adversely affected by three key macroeconomic developments:

  • First, there is a persistent gap between effective aggregate demand and potential output in most Member States – combined with high unemployment, a large overhang of private debt, low inflation and nominal interest rates close to their lower bound.

The shortage of demand (for both consumption and investment) is related to demographic trends, but also to rising inequalities and an increase in savings which are not channelled to the real economy but parked in financial instruments or metropolitan real estate.

  • Second, there is an unprecedented polarisation in economic and employment outcomes across the Eurozone.

This is linked to the incomplete character of the monetary union, notably the lack of aggregate demand management and absence of a shared fiscal capacity. The Eurozone’s design has, up till now, forced macroeconomic adjustment to unfold predominantly through internal devaluation.

  • Third, Europe struggles to reap the full job potential of structural changes under way, such as technological progress and further globalisation.

The reason is that our labour market institutions, but also product markets, financial sector and public investment agencies are not capable of reallocating labour and capital in a flexible but secure way towards activities with a strong job-creation potential.

The bottom line is that secular stagnation, permanently depressed employment and rising inequalities may well become reality if Europe’s economy continues to be characterised by a large overhang of private debts from the past and at the same time low inflation (see Teulings and Baldwin 2014).

 

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