Debate: Impact of the interest rate increase decided by the ECB on households and workers
Date: WEDNESDAY, 10 MAY 2023
Speaker: Nicolas Schmit
Language: EN

Starting from the second half of 2021, inflation has been rising strongly, reaching its highest level since more than two decades, and even more. While headline inflation has peaked in October 2022, core inflation, which excludes energy and unprocessed food, remains also high, but has edged down to 5.6% in April from a record high of 5.7% in March. High inflation reduces the purchasing power of citizens and makes many companies less competitive. Moreover, high inflation has a disproportionate impact on people with lower incomes. Following its mandate of pursuing price stability in the euro area, the European Central Bank has tightened its monetary policy to curb inflation because curbing inflation is a key objective. Of course, higher interest rates have important implications for the economy. Increased borrowing costs due to higher interest rates affect investment and consumption. This could reduce economic activity and in turn impact the labour market, which at the present moment is still quite strong. Households with variable—rate mortgages are particularly affected as the cost of servicing their mortgage increases. As a result, the disposable income of those households is shrinking. Increase of interest rates can also have a disruptive effect on highly indebted households and ultimately on the level of private debt, increasing the default risks. Against this background, it is important to assess and address the distributional effects of interest—rate increases on households and workers with a view to avoiding an aggravation of poverty and inequality while ensuring that our social security systems – as it was already said also by the Presidency – are well equipped to protect the most vulnerable households in the face of this challenge. But in this particular context, we also have to look at the impact of high inflation on wages, because it depends obviously also on wages, how households react to the increase of inflation and on the increase of interest—rate hikes. Nominal wages have increased – especially minimum wages have been updated in the last year. But at the same time, in 2022 real wages have decreased by 3%. Now, there is, as you know, a debate on the danger of a spiral between prices and wages. What we can say today is that wage—price spiral risks appear extremely contained. This has been confirmed by the IMF and the European Central Bank, which concludes in its March papers that wages have had only a limited influence on inflation over the past two years. And – interesting – the ECB papers conclude that the increase in profits had been significantly more dynamic than that in wages. Now, given the situation, I just want to quote also the IMF chief economist who in April pointed to another risk of inflation on one hand and the evolution of wages on the other hand. And he speaks of a cost—of—living crisis that could come up, and therefore pleads in favour of adjusting wages to reflect changes in purchasing power precisely to cushion inflation on one hand and the increased costs due to interest—rate hikes. To conclude, first, I think we have to factor in the cost of inaction as high inflation has a clear, harmful impact, and there is no choice between combating inflation. So I think what has been said by the Council is absolutely true. We have our main goal, which is to come back to price stability because inflation is strongly regressive, especially at the current juncture. Poorer households are more severely affected by high inflation as they spend a higher share of their income on food and energy consumption. Inflation is estimated to have already increased poverty and social deprivation by up to five percentage points in the EU, with important differences across Member States. So we have to come back, as I’ve already said, to price stability, as the economic and social consequences of higher and more persistent inflation would be even more dramatic. This situation, this challenging situation, requires, as already mentioned, also a targeted policy response and constant vigilance to support the European households and workers and the most vulnerable parts of society. And these support measures need to be targeted to those most in need, but at the same time, coming back to wage policy, because this is also a way how to preserve precisely purchasing power, we have to have appropriate wage adjustments. And especially in those sectors that can afford it, we have to maintain purchasing power – in this period of higher inflation and interest—rate rises – also not only to increases in minimum wages, but also to responsible collective bargaining.