Pablo Hernández de Cos, governor of the Bank of Spain, stressed this Monday that there is still no evidence that second-round effects of inflation are taking place, although he has recommended going ahead with the income agreement and promoting “selective” and concentrated measures in the lowest-income households -which are the ones that will suffer the most from the increase in inflation- and the most vulnerable companies in the face of the rise in the prices of raw materials.
“According to the information available, there is still no evidence that second-round effects are taking place, at least in a general way,” de Cos indicated in his speech at the Enrique Fuentes Quintana Conference Cycle, organized by the Royal Academy of Sciences Morals and Policies.
The governor has explained that it would also be desirable to avoid significant distortions in the signals provided by prices that encourage the economy to adapt to the energy shock. “And the necessary measures are temporary in nature so as not to generate an additional increase in public debt and the structural public deficit,” he insisted.
Urges to start a process of fiscal consolidation
On the other hand, the governor has pointed out that this fiscal policy action should be compatible with the start of a fiscal consolidation process, as early as 2023, in the most indebted countries or with a high public structural deficit, such as Spain, which will allow reduce current fiscal vulnerabilities and increase future room for manoeuvre. “It must also be taken into account that an appropriate use of European funds from the Next Generation EU (NGEU) program can make starting this process compatible with maintaining a positive impact of fiscal policy on economic growth”, he pointed out.
Salaries in the EMU have remained moderate
Regarding the effects of the second round, the governor has explained that wages in the EMU have remained moderate. In fact, there has been a significant drop in real wages. However, its growth is gaining momentum, supported by the strength of the labor markets and the effect of inflation on wage demands, factors that are expected to continue.
The governor has indicated that business margins have also remained, in general, moderate, although with great heterogeneity by country, company and sector. However, the transfer of costs to final prices has also been increasing and has been higher than in previous episodes. “To the extent that high real inflation persists, the probability of second-round effects increases,” he warned. For this reason, he believes that it is essential that economic agents add “as inevitable” the loss of income that the increase in the cost of imported raw materials implies.
In this sense, it advocates that, within the framework of social dialogue, the cost sharing be agreed between companies and workers, so that all assume an aliquot part of the loss of real income, with multi-year commitments regarding salary increases and the evolution of the margins. This general agreement should make it possible to differentiate according to the different sectors and agents affected, as well as to avoid automatic indication formulas for past inflammation, and should be strengthened by also avoiding the generalized use of autogastic indexation clauses.
The ability to pay has been affected
According to the governor, the combination of higher inflation and an expected economic downturn, together with the increase in interest rates, negatively affects the payment capacity of households and companies, especially in the case of the most vulnerable segments, characterized by their low income levels, their dependence on energy and food products and, in some cases, their high level of indebtedness. For its part, the high levels of public debt following the pandemic, together with the tightening of financing conditions, represent an element of vulnerability and limit the scope for adopting fiscal expansion measures.
The ECB will continue to increase rates “significantly”
As Hernández de Cos has warned, a greater persistence of inflation would force a greater tightening of monetary policy, which would increase the vulnerability of those agents -public or private- with a less healthy economic and financial situation, and to a greater extent anticipated, on their spending levels.
And that already from the Governing Council of the Bank to situate itself in the objective. The latest ECB projections maintain inflation at 2.3% in 2025, therefore above 2%. These projections were built on the basis of the expectations that the markets had regarding the evolution of interest rates at the time of their elaboration.
“If these projections are taken as valid, reaching the target would therefore require an increase in interest rates above what the market expected at the time,” said the governor. In fact, he explained that since the last meeting of the ECB Governing Council there has been an increase in the maximum level of interest rates expected by the market of around 25 basis points, to around 3.4%.
