Europe’s Wage Rises Are Aiding Recovery but Economies Face Risks

IMF Blog, November 9, 2023

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Canonical URL: Europe’s Wage Rises Are Aiding Recovery but Economies Face Risks

Authors: Chikako Baba, Ben Park, Ippei Shibata, Sebastian Weber
Date: November 9, 2023
Rising wages are supporting Europe’s economic recovery but, combined with long-term labor-market trends, could create inflationary pressures unless productivity improves and policy settings are appropriate.
Central banks and fiscal authorities should remain alert to upside inflation risks from wage growth and ensure the policy mix is appropriately tight to bring inflation back to target.

Nominal wages rose by 4.5 percent in the euro area in the first half of the year.
Nominal wages rose more than 10 percent in other parts of Europe in the first half of the year.
Higher wages are helping alleviate cost-of-living pressures and supporting economic expansion.

In much of Europe’s advanced economies, wages have further to rise before catching up with prices, implying persistent upward pressure on pay.
In Central, Eastern and Southeastern Europe, wage growth has been more rapid and has kept up with prices.
Historically, high wage growth in that region coincided with strong productivity growth; today productivity growth is weak, so continued high pay rises would chip away at competitiveness.

Over the past decade, Europe’s labor force participation grew relatively rapidly.
Even if participation trends continue, Europe’s labor supply (total hours worked) could decline by 0.1 percent annually over the next five years due to population aging, slower population growth, and shortening working weeks.
By contrast, the US labor supply is expected to grow by 0.2 percent as immigration and longer working hours more than compensate for a deterioration in demographics.
Employers face fiercer competition to find qualified workers because demographics and shorter working weeks squeeze labor supply.

Monetary policy:
- Central banks must watch for upside risks to inflation and closely monitor wage settlements and their consistency with productivity trends.
- A marked divergence between wage growth and productivity would be worrisome.
Fiscal policy:
- The mix of monetary and fiscal policy should remain appropriately tight to bring inflation back to target.
Structural reforms to raise productivity and relieve labor-market pressures:
- Increase productivity to lower inflationary labor-market pressures and raise longer-term growth potential.
- Boost the labor supply by:
- Allowing workers to work more hours.
- Making it simpler to transition between jobs.
- Equipping new generations for future jobs.
- Reskilling workers.
- Facilitating the integration of migrant workers.
Political constraints:
- Proposals to increase retirement ages further may face political opposition.
- There is little scope to increase average working hours because shorter work weeks are gaining popularity.

Source: Europe’s Wage Rises Are Aiding Recovery but Economies Face Risks (IMF blog), November 9, 2023.