Svante Öberg: The financial crisis and wage formation
Speech by Mr Svante Öberg, First Deputy Governor of the Sveriges Riksbank, at the
National Mediation Office, Stockholm, 29 January 2010.
* * *
Why is the Riksbank interested in wage formation?
Wage formation and monetary policy are interrelated. The development of wages affects
inflation and inflation affects the development of wages. The target for monetary policy is to
maintain a low and stable level of inflation. This job is made easier if wage formation works
well. Consequently, it is important for the Riksbank to follow this year's comprehensive wage
bargaining rounds.
I will not make any recommendations to the social partners regarding the outcome of this
year's collective bargaining. Instead, I will describe the economic setting for this collective
bargaining. This may seem to be an extremely subtle distinction, but it is an important one,
nevertheless. We make no normative pronouncements regarding which rate of wage
increase may be most appropriate. However, considering the drawn-out recovery and the
weak labour market, the scope for wage increases seems to be highly restricted.
I would also like to make two points during this introduction. Firstly: I will not be reporting any
new view of economic developments beyond that presented in the monetary policy update of
16 December, although a few figures will be updated with the latest statistics. Secondly: The
assessments and valuations I make here are not necessarily shared by all of my colleagues
on the Executive Board of the Riksbank.
I will start with the financial markets and international developments, before turning to
economic developments and monetary policy in Sweden, with particular attention paid to the
development of prices and wages.
The functioning of the financial markets continues to improve, but they have not
recovered completely
The functioning of the financial markets is continuing to improve, both in Sweden and
abroad. One sign of this is that various risk premia in the money and credit markets
continued to decrease during the second half of 2009. The levels of a number of risk premia
now seem to have stabilised within a historically normal interval. Possibilities for various
market participants to acquire funding at longer durations through the securities market have
improved. Moreover, the Riksbank's risk survey shows that access to funding without
government support has increased. The developments on the financial markets can be
illustrated by the so-called TED spread, the difference between the three-month interbank
rate and treasury bill rates (Figure 1).
However, despite this, the situation has still not completely normalised. There are still
markets that have not recovered. There also exists some uncertainty regarding the extent of
as-yet unrealised loan losses, particularly in European banks, leading to negative
consequences for confidence among financial market agents. Furthermore, it must also be
expected that bank lending in the United States and a number of other countries will be
restrained for some time to come. As far as Sweden is concerned, it can also be added that
developments in the Baltic countries represent an ongoing problem for the Swedish banks.
In addition, the financial markets are still dependent upon the measures adopted by central
banks and authorities to deal with the crisis (Figure 2). However, these extraordinary
measures will be successively phased out when central banks and governments deem that
the time is right. For example, we have ceased to issue dollar loans and have started to
increase margins on variable interest rate lending in Swedish kronor.
The lowest point of the international recession has now been passed, but uncertainty
remains regarding the strength of the recovery
The lowest point of the international recession has now been passed. World trade has made
a partial recovery following the steep decline of almost 20 per cent from the summer of 2008
to the start of 2009. The total trade volume, measured in terms of the World Trade Monitor
Index, rose by almost 9 per cent between January and October 2009 (Figure 3). GDP has
started to increase in both the United States and the euro area after a number of quarters
with negative growth.
In our December forecast, we expect the world economy to have declined by around
1 per cent during 2009, followed by an annual average growth rate of approximately
4 per cent for the next three years (Figure 4).
For the United States, we predict a relatively good growth rate (for a developed country), this
year and in the following years (Figure 5). GDP is expected to increase by an average
annual rate of just below 3 per cent for the years 2010-2012. Growth is expected to be
slower for the euro area. The annual growth rate in the euro area is expected to amount to
just below 2 per cent for the years 2010-2012.
Although GDP growth is now underway and is expected to continue during the forecast
period in both the United States and the euro area, it will be a long time until GDP returns to
pre-recession levels. This means that resource utilisation will be low for an extended period
of time. This applies not least to the labour market, which normally lags behind the
development of GDP. In turn, this will restrain price and wage developments abroad for the
next few years. I will return to this issue later on.
There is also considerable uncertainty about the strength of the recovery. The upturn in the
period immediately ahead will partly be driven by temporary factors such as the effects of
highly expansionary fiscal and monetary policies and an inventory cycle. There is therefore a
risk that growth will be dampened again when the stimulating effect of these temporary
factors declines. Experiences from previous financial crises, as reported by Reinhart and
Rogoff, the International Monetary Fund (IMF) and others, also indicate that the recovery
following a financial crisis will be drawn out.1 The differences between various forecasters'
views of future GDP growth are now unusually wide. This can be illustrated by the range of
their GDP forecasts (Figure 6).
Asia, however, is a part of the world experiencing strong growth. China and India have also
been impacted by the financial crisis, but to nowhere near the same extent as the more
developed countries. GDP growth declined somewhat in Asia in 2009, but was still high by
western standards (Figure 7). It is first and foremost China's increasing domestic demand
and imports that are stimulating growth in the region. The OECD's indicators also show that
GDP in Brazil and Russia has bottomed out and is now on the way up.
Low resource utilisation is restraining international price and wage development
Even if the international recession's lowest point has now been passed and the world
economy is improving, price and wage developments are being restrained by low resource
utilisation. Inflation is unusually low in both the United States and the euro area. In the United
States, inflation measured as annual percentage change has been negative since last spring
(Figure 8). In the euro area, inflation was negative during the summer and autumn of last
year, but rose to 0.6 per cent in November (Figure 9). Underlying inflation has fallen in both
geographical areas since the middle of 2008.
One contributing cause of this low and, for a period, negative inflation is the weak
development of the labour market. In the United States, employment levels have continued
to decline during the autumn, with unemployment rising to approximately 10 per cent.
Likewise, in the euro area, the situation in the labour market has continued to deteriorate and
unemployment has increased to approximately 10 per cent. An expected weak growth in
wages together with low inflation expectations is contributing towards dampening inflation.
Falling market expectations for the policy rate during the autumn may also be compatible
with lower expected inflationary pressure. Both survey results and implied forward rate
curves indicate that market participants' monetary policy expectations in the United States
and euro area have fallen somewhat during the autumn.
Sweden also experiences recovery but low resource utilisation
Developments in the rest of the world have impacted small, open, export-dependent
countries such as Sweden hard. However, even in Sweden, the lowest point of the recession
has been passed and recovery has started. GDP increased slightly during both the second
and third quarters of 2009, after having previously fallen four quarters in a row. The National
Institute of Economic Research's Economic Tendency Survey and Swedbank's Purchasing
Managers' Index have also reached levels indicating growth in the Swedish economy
(Figure 10).
In the most recent monetary policy update, from December, we saw ahead of us fairly strong
GDP growth for this year and the next two years (Figure 11). GDP is expected to increase by
an average of just over 3 per cent per year during the years 2010-2012. Swedish exports will
also increase at the same rate as economic conditions in the rest of the world improve.
Despite the weak development of incomes, private consumption is expected to continue to
rise over the forecast period, due to increased optimism regarding the future. Investment is
also expected to contribute towards GDP growth during the forecast period - first housing
investment and public investment, and then also investment in the business sector.
However, despite this growth in GDP, the economy will take a long time to recover. GDP is
not expected to return to its pre-crisis level until 2011 (Figure 12). As a consequence,
resource utilisation will be low during the forecast period. The labour market will also remain
weak during the entire forecast period. Employment is expected to continue to fall this year,
but to increase again next year (Figure 13). Unemployment will amount to approximately
10 per cent by the end of the year, but will then decrease over the following two years
(Figure 14). The most recent Labour Force Surveys indicate a slightly better development
than we expected in December. The manner in which this may affect the forecasts is a
matter we will return to at our next monetary policy meeting on 10 February.
Two factors give Sweden an advantage: the surplus in the public finances and the current
account before the start of the crisis (Figure 15). The public surplus has made it possible to
conduct an expansionary fiscal policy during the crisis without jeopardising the long-term
sustainable development of central government finances, which has mitigated the decline of
economic activity. Even in the period ahead, the basically strong public finances will
contribute towards a situation in which Sweden will not need to increase taxes and/or
decrease expenditure to the same extent as, for example, the United States and United
Kingdom in order to achieve the long-term sustainable development of public finances.
Significant uncertainty also as regards the strength of the recovery in Sweden
There also exists significant uncertainty as regards the strength of the recovery in Sweden.
The lowest point of the recession has undoubtedly been passed, but there is, as yet, no
strength in the recovery. Following a decline of over 6 per cent between the first quarters of
2008 and 2009, GDP has only increased by a total of 0.5 per cent during the second and
third quarters of 2009. Production in industry and the private service sector has not started to
increase as yet (Figure 16).
We expect to see fairly strong growth in GDP in the coming years. However, this expectation
may turn out to be overly optimistic - the risk of weaker development is also present. As in
the rest of the world, the upturn in Sweden in the period ahead will partly be driven by
temporary factors such as highly expansionary fiscal and monetary policies and an inventory
cycle. The forecast assumes that the world market will grow strongly, that private
consumption will increase at a good rate despite the fact that the development of household
incomes will be weak, that public consumption will increase and that investments will
increase despite a low level of capacity utilisation and weak profitability.
Naturally, there also exists the possibility that GDP growth will be stronger than we have
estimated. However, even with a higher rate of GDP growth, resource utilisation will be low -
and it is resource utilisation that is significant for inflation, not GDP growth. Resource
utilisation can be measured in different ways, but I will not address this issue today. I will
restrict myself to stating that resource utilisation can be measured by the GDP gap - that is
to say, the difference between the GDP level and what can be considered a normal level.
Even with a higher rate of GDP growth, the GDP gap will be negative and resource utilisation
low for an extended period (Figure 17).
The low resource utilisation does not only signify that inflationary pressures are low, but is
also a reason in itself to conduct a looser monetary policy. Through our monetary policy, we
are attempting not only to keep inflation at a low and stable level, but also to support
production and employment in the current recession.
A divided economy
The Swedish economy is divided, with a significantly worse situation in export-dependent
industries than in the private service sector. Even though the lowest point of the recession
has passed, we are still experiencing the effects of the crisis on world trade. The Swedish
export market has experienced a significant decline. At the same time, the expansionary
fiscal and monetary policies have enabled the activity level of those areas of the economy
focused on the domestic market to be maintained. This is clearly reflected in the
development of different sectors during the economic downturn. While industrial production
fell by over 20 per cent during the year leading up to the start of 2009, the production of
private services only declined by approximately 5 per cent during this period.
This divided economy has also been visible in the labour market. The labour market in export
industry dependent areas outside the major cities is far bleaker than it is in the
servicedominated major cities. While industrial employment decreased by approximately 100 000
between the autumn of 2008 and the autumn of 2009, employment within the service sector
remained largely unchanged (Figure 18).
Low inflation during the forecast period
We expect low inflation during the forecast period (Figure 19). The underlying inflation
measured as the CPIF (CPI with a fixed mortgage interest rate) is expected to be just below
2 per cent during the greater part of the forecast period. CPI inflation, on the other hand, will
vary significantly, as CPI also considers changes in interest rates on mortgages, which are
affected by the decisions we take regarding the repo rate.
Inflation measured in terms of the EU harmonised index, the HICP, has recently been higher
in Sweden than in the euro area (Figure 20). During the autumn, this was just below
2 per cent in Sweden, while it was negative in the euro area. HICP does not include prices of
owner-occupied housing, and thus inflation measured in terms of HICP and CPIF are largely
the same.
The relatively high HICP inflation in Sweden is primarily due to the heavy increase of unit
labour costs in Sweden over the last three years, averaging approximately 5 per cent per
year (Figure 21). In addition, the Swedish krona weakened during the financial crisis, pushing
up import prices. In turn, the rapid increase of unit labour costs over the last three years is
primarily due to the fact that productivity fell for three years in a row, in addition to which
hourly wages increased more during that three-year period than during the immediately
preceding three-year period.
This development will be reversed during the forecast period. We expect largely unchanged
unit labour costs over the next three years due to low wage increases and rising productivity.
We also expect the Swedish krona to continue to strengthen (Figure 22). This will mean that
inflationary pressure will be low during the forecast period.
Repo rate at all-time low
At the monetary policy meeting in December, the Riksbank decided to maintain the repo rate
at the all-time low of 0.25 per cent, standing fast by its previous assessment that it will not be
necessary to raise the repo rate until the autumn of 2010 (Figure 23).
The background to this decision is that a low level of resource utilisation, together with a slow
development of prices and wages, is expected over the next three years. In order to meet the
inflation target and to support economic recovery, the repo rate must remain low for a long
time. This is the same repo rate path that we adopted as long ago as July. Since then, the
forecasts for GDP growth and employment have certainly been revised upwards. The
forecast for resource utilisation has accordingly been revised upwards. However, at the same
time, the forecasts for inflation have been revised downwards. These two changes largely
cancel each other out as regards their effect on monetary policy.
Wage formation has functioned well for more than a decade
Wage formation has functioned well over the last ten to fifteen years. The development of
wages has been compatible with low and stable inflation. Since the inflation target was
adopted in 1995, CPIF inflation has averaged 1.7 per cent per year, seldom dropping below
1 per cent or rising above 3 per cent. This is a significant change when compared with the
high and sharply fluctuating inflation we experienced in the 1970s and 1980s.
The changes made to the frameworks for wage formation are an important factor behind the
lower and more stable inflation we see today. I am primarily thinking of the Industrial
Agreement implemented in 1997, but also of similar but less far-reaching agreements in
other areas of the labour market. I am also thinking of certain changes to the legislation and
the establishment of the National Mediation Office. Another factor should be that resource
utilisation has been kept at a lower level than previously, a level that is compatible with low
and stable inflation. The increased credibility of monetary policy in terms of keeping inflation
close to the inflation target of 2 per cent has probably also contributed. Inflation expectations
over the longer term now lie close to the inflation target (Figure 24).
Low wage increases during the forecast period
This year, social partners will negotiate just over 550 collective agreements covering just
over 3.3 million employees. The results of these negotiations will affect the wages of the
majority of the country's wage-earners, thereby being of great significance for economic
development.
The developments we see ahead of us, with a drawn-out recovery and weak labour market,
make it difficult to imagine anything other than that there will be low wage increases in the
period ahead. In December's monetary policy update, we expect wages to increase by an
average of approximately 2.5 per cent per year during the period 2010-2012, this figure
being slightly lower towards the start or the period and slightly higher towards the end
(Figure 25). However, this should not be interpreted as a recommendation, but rather as a
forecast based on developments in the economy and other available information. Naturally,
developments in this area may take a course deviating from our expectations, just as in other
areas. Wage increases include not just contractual wage increases but also wage increases
over and above central wage agreements.
Wage development forecasts form a part of the overall forecast for the Swedish economy.
We base our wage forecasts on the short-term wage statistics of the National Mediation
Office, with adjustments made to the preliminary statistics for estimated retroactive wage
payments. Following this, a forecast is made in two stages. The first stage covers the next
six months, considering previously agreed wage increases, the situation on the labour
market and inflation expectations. The second stage covers the next two to three years and
considers unemployment, corporate profits and inflation expectations. As in other forecast
areas, a final assessment of wage developments is made in consideration of model results
and other information not included in the models.
The financial crisis and wage formation
The financial crisis has affected the Swedish economy in two ways. Firstly, the financial
markets and the financial sector have been impacted negatively. However, in principle, this
problem has now been addressed. Central banks and authorities have adopted extraordinary
measures which have succeeded in getting the financial markets to function better again.
The remaining areas to be addressed are that the financial sector is still dependent upon
government support, that there exists a risk that new problems will arise and that a new
regulatory framework is needed for the financial sector.
Secondly, the financial crisis has led to a decline in world GDP and world trade. As regards
Sweden, this has primarily impacted the Swedish export industry and has led to a deep
recession from which it will take the country a long time to emerge. Other parts of the
economy that are focused on the domestic market have coped better, due to the expansive
fiscal and monetary policies being conducted, among other factors. This has led to a clear
division of the Swedish economy.
This is the economic background against which the social partners are to conclude wage
agreements during the year. This will not be an easy task. It will require a variety of
deliberations to be undertaken.
As I have previously stated, against the background of the drawn-out recovery and the weak
labour market, we at the Riksbank expect a wage increase rate for 2010-2012 of
approximately 2.5 per cent per year, lower at the start and higher towards the end of the
period. This is a very low rate of increase, historically. Our forecast will no doubt be
considered to be too high by many on the employer side and, likewise, too low for many on
the union side.
The wage development we expect is consistent with an underlying inflation rate reaching
2 per cent by the end of the forecast period. All other factors being equal, higher wage
increases in this situation tend to lead to higher inflation, higher interest rates and a weaker
development of production and employment. Similarly, lower wage increases tend to lead to
lower inflation, an ability to maintain low interest rates for a longer period of time and a
stronger development of production and employment.
One factor that will undoubtedly play a major role in the approaching rounds of wage
bargaining is the division of the Swedish economy. The differences in the ability of various
industries and companies to bear a certain rate of wage increases are currently unusually
great. The development of wages along similar lines in different parts of the economy would
lead to smaller pay differences, but also to a faster transformation of the economy. This
would hit the regions impacted by the crisis hardest and the number of industrial jobs would
decline more rapidly.
Another important question concerns the implications of the division of the economy for the
Industrial Agreement's normative role in wage bargaining, a role which has been very
important during the most recent agreement periods. The Industrial Agreement has been a
restraining force, contributing towards retaining the competitiveness of that part of the
Swedish economy exposed to international competition and keeping inflation at a low and
stable level at the same time as real wages have risen and growth in the Swedish economy
has been strong - until the financial crisis.
In the period ahead, a drawn-out recovery, weak labour markets and low price and wage
increases are also expected internationally. The sector exposed to international competition
is the area of the Swedish economy to be most tangibly and directly affected by these
external conditions for wage developments within Sweden. This suggests that this sector
should also play a normative role in this year's collective bargaining. The service sector is not
as sensitive to cost increases, but finds it easier to pass these on to prices. If the service
sector plays a normative role in this year's collective bargaining, it is likely that wage
increases, and thereby inflation, will be greater than would be the case if the sector exposed
to competition were to be normative.
Another issue that may play a major role is uncertainty concerning the future. Under normal
circumstances, agreements covering several years are an advantage, as these reduce
uncertainty regarding future price and wage developments. However, the current situation is
not normal. This means that making contractual commitments in respect of agreements for
longer periods of time may be difficult.
As I mentioned in my introduction, I have no advice regarding the outcome of this year's
collective bargaining. Instead, I have tried to describe the economic setting for this collective
bargaining. The necessary deliberations must be undertaken by the social partners together.
Concluding remarks
Wage formation has functioned well over the last ten to fifteen years. It has contributed to our
success in maintaining inflation on a low and stable level, at the same time as real wages
and growth have developed strongly. My hopes are that this year's collective bargaining will
contribute towards Sweden's continued positive economic development, once the effects of
the financial crisis have ebbed away.
Figures
BIS Review 11/2010
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BIS Review 11/2010