MNI ANALYSIS: IMF Wage Paper Suggests Prudence By Fed, ECB

--IMF Stresses Need To Assess Impact Of Involuntary Part-time Workers

--IMF Paper Suggests Trend Productivity Important for Wages, Inflation

--IMF Paper Warns Automation May Weigh on Wages in Future

By Sophia Rodrigues

     SYDNEY (MNI) - The conclusion from an analytical paper published by the

International Monetary Fund on wage dynamics suggests the Federal Reserve may

have to go slow on further policy tightening and the European Central Bank may

need to delay the unwinding of its accommodative monetary policy stance.

     The IMF paper, published Wednesday, says involuntary part-time employment

and trend productivity are important in judging the degree of slack in the

economy beyond the unemployment rate, and they are likely to be key determinants

on how long monetary policy needs to stay accommodative and what the appropriate

pace of exit from accommodative policies should be.

     Involuntary part-time workers refer to those who work part-time but would

like to work more hours. They are also referred to as part-time workers for

economic reasons.

     The paper also suggests increasing cross-border economic linkages may be

contributing to wage weakness and warns that automation could weigh

significantly on wage growth in the future.

     The paper, which will be part of the World Economic Outlook to be published

on October 10, studied the recent wage dynamics in advanced economies from the

starting point that nominal wage growth in most advanced economies remains

markedly lower than it was before the Great Recession of 2008-09.

     The main takeaway from the paper that could be relevant for the Fed is that

a slowdown in trend productivity growth will continue to be a headwind to wage

growth even if the unemployment rate declines. For inflation to pick up,

involuntary part-time employment needs to diminish or trend productivity needs

to pick up. 

     "Assessing the true degree of slack beyond measured headline unemployment

rates will be important when determining the appropriate pace of exit from

accommodative monetary policies," the paper said.

     The paper estimates that in economies where unemployment rates are now

below their averages before 2007, slow productivity growth can account for about

two-thirds of the slowdown in nominal wage growth.

     The San Francisco Fed published a paper in June 2015 discussed how the

involuntary part-time unemployment rate relative to overall unemployment rate

hadn't fallen by as much as in past recoveries. The paper noted that in May 2015

the involuntary part-time rate was 4.2% when the jobless rate was 5.5%, whereas

in previous two economic recoveries the involuntary part-time rate corresponding

to same jobless rate was 3.2%, indicating more slack in the labor market this

time around.

     For the ECB, the IMF paper's observations on economies where jobless rates

are still appreciably above their averages before 2007 is more pertinent.

     In such economies, conventional measures of labor market slack can account

for about half of the slowdown, with involuntary part-time employment acting as

a further significant drag on wages, the paper said.

     "In these economies, wage growth is unlikely to pick up unless slack

diminishes meaningfully -- an outcome that will require continued accommodative

policies to boost aggregate demand," the paper said.

     A paper published by the ECB in March this year estimated that on top of

the unemployment rate, about 3.5% of the working age population are marginally

attached to the labor force - that is, categorized as inactive, but simply

competing less actively in the labor market. There was a further 3% or around

seven million of the working age population who were involuntary part-time

workers. Both added to the slack in the economy.

     "Combining the estimates of the unemployed and the underemployed with the

broader measures of unemployment suggests that labor market slack currently

affects around 18% of the euro area extended labor force. This amount of

underutilization is almost double the level captured by the unemployment rate,

which now stands at 9.5%," the ECB paper said.

     "As well as suggesting a considerably higher estimate of labor market slack

in the euro area than shown by the unemployment rate, these broader measures

have also recorded somewhat more moderate declines over the course of the

recovery than the reductions seen in the unemployment rate," it added.

     In its most recent monetary policy statement, the ECB noted that labor

market slack was still significant but expressed optimism that a prolonged

period of growth above potential implied a progressive closing of the output gap

and the reabsorption of labor market slack, supporting a gradual rise in

inflation over time.

     The IMF paper concludes that the bulk of the wage slowdown since the

recession can be explained by labor market slack, including involuntary

part-time employment, as well as weak inflation expectations and low trend

productivity growth. 

     Another interesting takeaway from the paper is how economic and labor

market conditions in one economy are affecting conditions in other economies, in

turn exerting increasing downward pressure on wage inflation in the aftermath of

the global financial crisis and especially during 2014-16. 

     "The finding of sizable common factors behind wage weakness could indicate

the growing effect on wage setting in any given economy of labor market

conditions in other countries in the context of stronger cross-border economic

integration," the paper said.

     "It could also point to the role of broad-based and synchronized demand

weakness across many countries and heightened concern about job losses, which

may have hindered wage growth in the aftermath of the global financial crisis

and the euro area sovereign debt crisis," the paper added.

     The paper also discussed the effect of automation, which has so far made a

small contribution to wage weakness but could have a bigger impact in the

future. It used the relative price of investment goods as a proxy for the impact

of automation. 

     "Automation appears to have made a small contribution to subdued wage

dynamics following the Great Recession due to a limited decline in the relative

price of investment goods in recent years compared with the previous downward

trend," the paper said.

     "The analysis suggests that automation could weigh on wage growth more

substantially in the future if the decline in the relative price of investment

goods were to pick up again," it added. However, it also pointed out that

inferences about the impact of automation are not straightforward given that, as

noted previously, the relative price of investment goods is just one channel

through which its influence on wage growth may play out.

--MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@marketnews.com

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