26.04.2022
The case for an incomes agreement in Spain?*
50th anniversary of the Faculty of Economics and Business Studies
Universidad de Sevilla
Pablo Hernández de Cos
Governor
*hEnglish translation of the original speech in Spanish.
Good morning,
I should like to take this opportunity to share with you some reflections on the current
economic environment, which, more than two years after the outbreak of the pandemic, is
tragically marked by the invasion of Ukraine. The repercussions of this war, albeit difficult to
predict, can be expected to be global and extremely severe, for both the geopolitical and
the economic situation. In the short term, its adverse effects on activity and inflation will
come through a number of channels, the impact of which will be more acute in Europe,
given its greater interconnectedness with the countries at war.
I will first describe the main features of the current economic situation, which is affected by
the consequences of the war. Subsequently, I shall analyse the essential features of the
economic policy response to the challenges of the war in Ukraine and its repercussions. In
particular, I would like to stress the need for a broad incomes agreement for the coming
years in Spain, the possible content of which I will detail later on. This need is justified by
the initial description of the current situation and outlook for the Spanish economy, in
particular as regards inflation.
The current economic situation
Before the war, the world economy was on a path of gradual recovery, following the
most acute phase of the pandemic, although the recovery was already flagging from the
second half of 2021 owing to global bottlenecks and the increase in inflationary pressures.
The gradual path of recovery in activity prior to the Russian invasion of Ukraine was, in any
case, highly uneven across geographical areas and sectors of activity. Thus, while some
economies had already regained or even surpassed their pre-crisis levels of activity, others
had not. Spain, despite having one of the highest levels of vaccination in the world, was
among the latter. At the end of 2021, Spain's output was still 3.8 percentage points (pp)
below its pre-pandemic levels, while in the euro area as a whole this gap had already closed.
One factor that would explain the difference in progress is the sectoral composition of
activity. In particular, the recovery tends to be more delayed in those countries, like Spain,
in which services that are highly dependent on personal interaction, such as those linked to
tourism, account for a large share of the economy.
Economic developments in Spain, and in the rest of the world, have been affected by
upward inflation surprises since the second half of 2021, driven in particular by energy and
food, although there has also been a slight rise in underlying inflation. Between December
2020 and March 2022, the annual increase in consumer prices rose from -0.6% to 9.8%.
The persistence and intensity of inflationary pressures reflect a combination of various
demand and supply factors. Notable among the demand factors are the relatively strong
recovery in activity following its collapse in 2020 and the changing consumption patterns as
a consequence of the pandemic and the measures adopted to contain it. Among the supply
factors, the higher price of energy - with major strains in the gas market - and the disruption
to global supply chains stand out. This high global inflation environment was also reflected
in expectations of monetary policy normalisation and, in consequence, a moderate
tightening of private-sector financing conditions.
As at global level, the repercussions of the war for the Spanish economy are highly
uncertain. Spain's direct exposure to the countries at war is low. However, the invasion of
Ukraine has also changed the economic environment and represents, at a time when the
recovery from the pandemic remains incomplete, a new shock that can be expected to entail
adverse consequences in the coming quarters for economic activity and inflationary
pressures through various channels.
Of these channels, the most important is probably commodity markets, including
markets for both energy and non-energy commodities, in particular foodstuffs and metals,
of which Russia and Ukraine are both significant global producers and exporters. Spain's
direct exposure to these imports is relatively low; for example, in 2019 only 6% of its total
energy purchases from the rest of the world came from Russia. This percentage is much
higher in countries such as Germany and Italy (17% and 22%, respectively).
However, in a highly volatile environment, the war is affecting the cost of these goods on
global markets, irrespective of their origin. In particular, the rise in energy prices has
significant effects on the cost of the household consumption basket and on firms' costs of
production. Also, the war itself could ultimately hamper the supply of some of these goods,
which would obviously tend to have a large impact on prices and economic activity. The
European authorities have formally announced their intention to reduce structural energy
dependence on Russia, but clearly this is not something that can be achieved in the short
term.
The surge in inflationary pressures apparent in the March data partly reflects the increase in
commodity prices associated with the war, but also the delayed effects of the acceleration
in intermediate costs in the preceding months on the prices of other goods and services,
and the scarcity of certain products as a result of the road hauliers' strike.
The impact of the increase in energy costs is highly uneven across groups of agents. In the
case of households, those with low incomes are most affected. In the case of productive
sectors, the impact is naturally greater on the more energy-intensive ones.
A second channel, that is also very significant, is the impact of the war on household and
business confidence, given the extraordinary uncertainty surrounding the duration and
course of the war. This, in turn, introduces uncertainty over the behaviour of the incomes of
these agents, which means they tend to postpone their consumption and investment
decisions.
The sharp decline in the consumer confidence indicator in March (the largest decrease in
the historic time series, which goes back to July 1986) gives an indication of the magnitude
of these effects. This fall suggests that the increase in uncertainty may have begun to
adversely affect household spending decisions. The results of the latest edition of the Banco
de España Business Activity Survey (EBAE) suggest that the war has begun to worsen the
expectations of non-financial corporations regarding their turnover and also the duration of
the global supply chain problems, which is now estimated to be longer.
Third, the invasion of Ukraine will affect the Spanish economy through the trade channel,
the direct impact of which is assumed to be moderate, as bilateral trade flows with the
countries at war are relatively limited. In 2019, the last year before the pandemic, Spanish
goods exports to Russia and Ukraine represented only 1.6% and 0.3% of the total,
respectively. Russian tourism, meanwhile, accounted for 2.2% of total spending by foreign
tourists.
However, the indirect effects on Spanish trade flows may be significant. The war will
particularly affect central and eastern European countries, which are more exposed to
Ukraine and Russia, and, therefore, the growth of Spanish export markets. Further, the
invasion is having a negative impact on the global supply chains for certain productive
processes, with signs of a worsening of bottlenecks, after the partial improvement in the
fourth quarter of 2021, although the lockdowns in China to check the pandemic may also
have contributed to this. In any event, the latest indicators of export orders point to a
slowdown in trade flows.
Amid so much uncertainty, preparing macroeconomic projections is even more complicated
than usual. The Banco de España's latest forecasts,1 published on 5 April, confirm that
the gradual recovery in activity has been blown off course by the invasion of Ukraine:
GDP growth has been revised down and inflation up, compared with the previous
projection exercise in December 2021.
These projections were prepared on the basis of still-incomplete information for the first
quarter of the current year. According to the data available, the recovery in activity continued
in the period leading up to the war. This is reflected, for example, in the information on social
security registrations, despite the effects of the spread of the Omicron variant of COVID-19,
probably due to the beneficial effects of the high rate of vaccination. However, the same
social security registrations data also show that employment growth had already begun to
falter in March and early April, following the invasion of Ukraine.
Through the above-mentioned channels, the war has led the output growth projections for
2022 and 2023 to be revised downwards by 0.9 pp (to 4.5%) and 1 pp (to 2.9%),
respectively.
Specifically, in the case of the 2022 revision, on Banco de España estimates, higher
commodity prices, increased uncertainty and the lower growth of world markets will reduce
growth by 0.7 pp, 0.6 pp and 0.5 pp, respectively. These factors by far outweigh others
operating in the opposite direction. These include the fact that, on the latest Quarterly
National Accounts (QNA) figures published,2 GDP grew more vigorously in the second half
of 2021 than anticipated in the December projection exercise. Likewise operating in favour
of output growth is the stimulus provided by the measures included in the National Plan to
respond to the economic and social consequences of the war in Ukraine, approved on 29
March by the Spanish Cabinet,3 to which I will refer briefly later on.
In any event, assuming that the war will not extend over a long time horizon, activity will
continue to be underpinned by the foreseeable improvement in the epidemiological
situation, use of the Next Generation EU (NGEU) funds and financing conditions that, while
somewhat tighter than in previous quarters, remain favourable.
Turning to the inflation forecasts, in step with the paths of the corresponding futures
markets, the upward pressures of the energy component are expected to peak in the
second quarter of 2022 and then decelerate. The inflation projections rest on two
assumptions: (i) that, in line with the information from the EBAE, the pass-through of higher
intermediate costs to final prices will only be relatively moderate (albeit more forceful than
envisaged in the December projection exercise); and (ii) that the second-round effects will
be limited, i.e. scant feedback effects between inflationary pressures on prices and wages.
Inflationary pressures will be partly alleviated by the measures contained in the National
Plan to respond to the economic and social consequences of the war in Ukraine.4
Furthermore, these projections do not yet include the possible changes in prices on the
electricity market that are currently being negotiated in the European Union.
Against this backdrop, the projections see inflation standing at 7.5% in 2022. It will then fall
in 2023 to around 2%, thanks, above all, to the moderation of the energy component.
Underlying inflation will not start to decline until end-2022, once the upward pressures on
firms' costs associated with energy prices and bottlenecks have corrected. On average, it
will rise to 2.8% in 2022 as a whole, but then gradually slow over the rest of the projection
horizon. Compared with the December projection exercise, the inflation forecast for 2022 is
revised upwards significantly (by 3.8 pp), due, above all, to the recent energy component
surprises.
The balance of risks in this projection exercise is tilted to the downside in the case of
economic activity and to the upside in that of inflation, amid extraordinary uncertainty
as a result of the war in Ukraine and its geopolitical implications. In particular, economic
activity and inflation will be very sensitive to energy and commodity market developments,
to the hypothetical emergence of second-round effects on prices and wages and to the path
of household consumption and saving. By way of example, later on I will describe in some
detail the adverse repercussions for the Spanish economy of such second-round effects,
underscoring the need to adopt an economic policy response that pre-empts these risks via
an incomes agreement.
The economic policy response
The magnitude of the effects of the war will also ultimately hinge on the economic
policy response, which has a crucial role to play. Allow me to offer a few thoughts on
that response.
European economic policies
Like the pandemic, the invasion of Ukraine is a very adverse, exogenous shock
common to the European Union (EU) as a whole, albeit with uneven effects across
countries, sectors and firms.
This is a very important consideration that must steer the debate about what role the
different economic policy instruments should play. In my view, given it is a common shock,
the optimal response would be forceful pan-European action that mitigates, in the short
term, the economic effects, particularly for the most vulnerable agents. Furthermore, in the
medium term, this crisis stresses the need to boost Europe's strategic autonomy in terms
of both energy and defence.
Indeed, joint European action, ideally through the pooling of budgetary resources, is once
again the most effective means of funding the resulting increase in public expenditure.
This common response should stave off a persistent deterioration in the economic outlook
and, in tandem, eliminate a potential new source of financial fragmentation in Europe.
As part of the RePowerEU initiative, the European Commission has proposed a plan to
reduce the EU's demand for Russian gas by 60% by the end of 2022. Spain has a key
role to play here, given that it accounts for 25% of the EU's regasification capacity.
However, to fully exploit this capacity investment will be required in cross-border
interconnections to eliminate the existing bottlenecks. In response to rising energy prices,
under the plan options would also be explored to optimise the design of the electricity
market in view of the foreseeable changes in the energy mix. A further possibility is to
temporarily ease the State aid framework for the business sector and establish certain
temporary limits on retail electricity prices.
More broadly, the war has underlined the need to accelerate European integration so that
the EU is an important player on the global stage, capable of deciding its own future and
defending its values.
A cornerstone of this integration is the creation of a common and permanent fiscal
capacity in the euro area, which would facilitate the economic policy response to severe
shocks. The design of this common fiscal capacity must be based precisely on the lessons
learned from NGEU and the instrument for temporary Support to mitigate Unemployment
Risks in an Emergency (SURE), which were implemented to deal with the pandemic, and on
any lessons we might draw now from our response to the war.
The financial realm is a second area of economic integration. Pan-European bond
issuances to fund NGEU, and any other potential issuances as part of the response to the
invasion of Ukraine, are an important step towards creating a European safe asset. In
addition, deeper capital market integration in the euro area would pave the way for greater
risk-sharing in the face of asymmetric shocks.
Lastly, a third necessary element to bolster the euro area's institutional architecture is the
completion of the banking union, establishing a European deposit insurance scheme and
a common framework for resolving systemic crises.
The European Central Bank's monetary policy
Against the recent backdrop of high inflationary pressures, the European Central Bank
(ECB) has continued with the normalisation of its monetary policy initiated last
December. The Governing Council has explicitly expressed its willingness to maintain
optionality, gradualism and flexibility in the conduct of monetary policy going forward.
In the current climate of uncertainty, this is deemed necessary to allow us to respond to
incoming data to fulfil the ECB's mandate to pursue price stability and to contribute to
safeguarding financial stability.
Indeed, the war in Ukraine is increasing the short-term upward inflationary dynamics,
adding to the pressures generated by rising energy prices, bottlenecks and the
normalisation of demand. The intensification and prolongation of these short-term
inflationary pressures make it more likely that second-round effects will emerge and,
therefore, that the inflation dynamics will become entrenched in the medium term. However,
the war is having an adverse effect on economic growth, which could potentially be
significant, particularly in the short term, in a setting where euro area GDP remains below
its potential level.
Overall, the upside risks to the inflation outlook have intensified, particularly in the
near term. Although various indicators of long-term inflation expectations drawn from
financial markets and surveys of professional forecasters put inflation at around 2%, there
are preliminary signs, which will have to be monitored carefully, of those indicators being
revised to above-target levels.
In step with the normalisation of monetary policy, net purchases under the pandemic
emergency purchase programme (PEPP) were discontinued on 31 March. The maturing
principal payments from securities purchased under the PEPP will be reinvested until at
least the end of 2024, and in the event of renewed market fragmentation related to the
pandemic, PEPP reinvestments can be adjusted flexibly.
Further, at our meeting of 14 April, the Governing Council judged that the incoming data
reinforced our expectation that net asset purchases under the asset purchase
programme (APP) should be concluded in the third quarter of 2022.
We also indicated that the raising of key ECB interest rates will take place some time
after the end of the net purchases and will be gradual.
Lastly, the ECB Governing Council stated that we stand ready to adjust all of our
instruments within our mandate, incorporating flexibility if warranted, to ensure that
inflation stabilises at its 2% target over the medium term. The pandemic has shown
that, under stressed conditions, flexibility in the design and conduct of asset purchases has
helped to counter the impaired transmission of monetary policy and made the Governing
Council's efforts to achieve its goal more effective. Within the Governing Council's mandate,
under stressed conditions, flexibility will remain an element of monetary policy whenever
threats to monetary policy transmission jeopardise the attainment of price stability.
In step with the communication of this process of monetary policy normalisation,
market expectations of policy rate hikes have been brought forward since December.
The prospect of the monetary policy stance returning to normal has likewise been
reflected in an upturn in long-term interest rates in the euro area. Specifically, the
10year OIS rate, which proxies the euro area risk-free interest rate, has risen by 170 bp since
the beginning of the year.
Domestic fiscal policy
Domestic economic policies also have a key role to play in the current climate.
But fiscal policy headroom is constrained by high government debt and structural
budget deficits.
It is therefore important for domestic fiscal policy to exploit its capacity for highly
granular action focused on the households, firms and sectors most vulnerable to this
combination of shocks, many of which had not yet fully recovered from the adverse effects
of the pandemic. In particular, fiscal policy action should target lower-income households,
which bear the brunt of inflation, and more energy-intensive firms.
Moreover, again with the aim of minimising their impact on budgetary imbalances, it is
important that the fiscal policy measures be temporary so as not to further increase the
structural deficit, and that the instruments used do not skew price signals, which
would hinder the adjustment in demand.
Likewise, averting any feedback into the current inflationary process is further reason to
avoid an across-the-board fiscal impulse and the widespread use of automatic
indexation clauses in expenditure items. This deindexation must be part of the incomes
agreement to which I will return later.
It is against this background that the measures adopted to soften the economic and social
consequences of the war must be assessed. The National Plan to respond to the economic
and social fallout of the war in Ukraine, approved by the Spanish Cabinet on 29 March,5
includes measures that will come at a direct cost of €6 billion in 2022, according to
Government estimates.67
One area of fiscal policy where more resolute action would be desirable is the formulation
of a credible commitment to budgetary stability over the medium term. This would help limit
the risks of financial market tensions that could be fuelled by the current climate of high
uncertainty. This commitment should take the form of a gradual fiscal consolidation
programme, to be implemented once the recovery takes hold. A gradual adjustment
process minimises the possibility of any abrupt changes in the budgetary policy stance that
might hamper the recovery under way.
Increasing the economy's potential output would also help reduce the high level of
government debt. This would require reforms that address the economy's structural
shortcomings. NGEU funds could also be particularly useful in implementing these
reforms and the investments required to support the changes.
Need for an incomes agreement
There is an additional dimension to the response to the current situation, one that is highly
specific to the present shock and of the utmost importance. Specifically, as I have
explained, the attack on Ukraine has exacerbated the geopolitical tensions that were already
driving steep price rises in energy commodities, the bulk of which we import from abroad.
This increase in the price of imported energy amounts to a loss of income for the Spanish
economy. And as I have reiterated on a number of occasions, lower income for the
economy as a whole inevitably entails a reduction in its agents' income.
Against this background, these agents (essentially firms and households, but also general
government) would be well-advised to internalise this reduction in national income and
reach a burden-sharing agreement, so as to avoid triggering a price-cost feedback loop.
Such a spiral in Spain would only exacerbate the pernicious effects of the current shock,
since, in the present context, a simultaneous rise in prices and wages would erode our
external competitiveness vis-à-vis other euro area countries and would aggravate the
already harmful effects of the current shock on competitiveness, employment and economic
growth. Further, were it to spread across the euro areas as a whole, such a feedback loop
would require a more aggressive normalisation of the ECB's monetary policy to ensure
compliance with our price stability mandate.
In my view, an incomes agreement, like the one I have been advocating since October, is
warranted in order to ward off these scenarios. But what shape should this cost-sharing
agreement take? In my view, this burden-sharing should be set out in an agreement forged
under the framework of social dialogue (which we have termed an "incomes agreement
between firms and workers"). However, I believe it should be defined based on certain
general principles. I will specifically mention five that I feel are particularly important.
First, the costs must be shared among all agents. In an extreme scenario in which firms
attempt to keep their unit profits intact, a reduction in household purchasing power would
ultimately translate into lower demand for firms' products. At the other extreme, maintaining
workers' full purchasing power would pose a threat to firms' capacity to generate sufficient
funds to conduct their investments and, ultimately, would jeopardise their survival, to the
detriment of employment and welfare.
The information available to date suggests that such cost sharing across firms and
workers is already taking place on a tacit basis. Specifically, in the collective bargaining
agreements registered to March the wage increases for 2022 stood at 2.4%, well below the
recent increase in consumer prices and that expected for 2022 as a whole. Therefore, in
practice workers are losing purchasing power.
That said, in large part, this increase essentially reflects the deals struck by the social
partners in the multi-year collective bargaining agreements negotiated over the past two
years in an inflationary setting that bears little resemblance to the current one. There are
therefore signs that this stabilisation mechanism is running out of road. With this in mind, I
believe that concrete action is needed.
Similarly, in the case of businesses, recent data reveals that they have not fully passed
on their rising costs to their customers, and their margins are therefore likely to have
been squeezed. This can be inferred, for instance, from the feedback from Spanish firms
in the latest edition of the EBAE for the first quarter of 2022. According to the survey, around
82% of businesses saw their costs rise as a result of higher input prices, whereas just over
40% raised their selling prices.
Second, the asymmetric impact of the current shocks on workers, firms and sectors
must be borne in mind when determining the specific features of the incomes
agreement. The necessary coordination at national level must therefore be combined with
mechanisms to ensure the agreement is able to cater to the existing productivity and
activity-related differences across firms and sectors.8 Equally, where the standard of living
of certain segments of households is hit particularly hard by rising energy costs, the incomes
agreement should naturally seek to mitigate their straitened circumstances. In short, these
considerations reveal the need to avoid overly sweeping measures to implement a potential
incomes agreement that might prove too rigid for certain groups of agents.
Third, any approaches that automatically link wages to past inflation or indexation
clauses are also to be avoided9. The aim is precisely to reduce the risk of triggering a
wage-price feedback loop. In this regard, workers with collective bargaining agreements
registered up to March this year that provide for any form of wage guarantee clause linking
the final wage increases agreed in 2022 to developments in inflation are admittedly in the
minority. Nonetheless, the figure (30%) is notably higher than it was at the end of 2021,
when it stood at 17%. Of even more concern is the fact that this figure rises to 50% of the
total when considering the agreements entering into force in 2023, albeit still referring to a
small number of agreements in this case.
Fourth, any incomes agreement should provide for multi-year wage increase and job
protection-related undertakings. This would offer households and businesses some
certainty in their spending and investment decisions. Any agreements concerning wage
increases should take their lead from the underlying inflation. These recommendations apply
to both wage increases and, where applicable, to potential wage guarantee clauses.
Arrangements such as these have already been used by the social partners in the past and
have proven a useful tool for protecting jobs, making firms more competitive and spurring
economic growth.10
Fifth, these guidelines on wage developments should be accompanied by explicit
commitments to moderate profit margins. Only then will such wage restraint actually
make firms more competitive, while, in turn, limiting the extent to which rising energy input
costs are passed through to other goods and services in the economy. And some sort of
mechanism would have to be set in place to ensure this restraint in profit margins can be
verified.
The simulations performed using the Quarterly Macroeconometric Model of the Banco
de España (MTBE) underscore the benefits of a successful incomes policy. The MTBE
makes it possible to estimate how a reaction in other domestic prices and in private wages,
in line with the direct impact of higher energy prices on the general price level, might affect
activity and employment. If higher energy prices are fully passed through, the overall
adverse impact on activity and employment, in terms of the divergence from the current
projections, could be around 1.5 pp in 2024. Moreover, real disposable household income
would decline, owing to the fall in employment and a further increase in inflation.
Conclusions
I will end by highlighting three key messages I would like you to take away from my speech
at this critical historical juncture in which the attack on Ukraine could represent, as well as
an extraordinary human tragedy, a serious threat to the European social and political project.
First, in a variety of ways, the war will undermine the gradual post-pandemic recovery under
way, though we can for the time being only hazard a guess at the scale of the fallout. As is
only to be expected, the impact will depend on the severity and duration of the conflict. In
this regard, the Banco de España's latest projections point to a substantial downgrade in
GDP growth in 2022 and 2023, while the rate of inflation is expected to rise sharply this year.
Second, economic policies have a pivotal role to play in this scenario. On the one hand,
European economic policies and domestic fiscal policies must respond decisively, providing
targeted support to the most vulnerable households, businesses and sectors affected, and
offering certainty. It is important to ensure that such action is indeed selective and temporary
in the case of the fiscal policy of a country like Spain, whose room for budgetary manoeuvre,
already very limited before COVID-19, has been significantly further eroded as a result of
the pandemic.
Meanwhile, amid sharply rising inflation, the ECB has taken gradual steps towards
normalising its monetary policy, already leading to a slight tightening of financial conditions.
Looking ahead, monetary policy decisions will depend on the new data and, given the
significant degree of uncertainty, flexibility, gradualism and optionality will be maintained.
We are clearly committed to adopting all such measures as may be necessary to ensure
price stability and safeguard financial stability.
Lastly, amid the current upsurge in the price of energy and certain other commodities, it is
vital to guard against the emergence of second-round inflation effects, particularly in the
form of a wage-price spiral. In the short term, preventing this feedback loop is neither easy
nor, above all, agreeable. It calls for an incomes agreement between workers and employers
under which everyone emerges better off in the medium-term, although everyone must take
a hit in the short term. The widespread use of automatic indexation clauses in public
expenditure must also be avoided. In a climate as uncertain as the current one, an
agreement of this nature would provide a very valuable dose of stability and certainty,
allowing the duration and costs of the current inflationary shock to be kept to a minimum
and paving the way for the necessary economic adjustment, generating more jobs and
improving the welfare of the general public. The performance of our economy in the coming
years in large part rests on our ability to reach these difficult agreements.