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Economic Performance EMU Fiscal Policy

Krugman: Nominal Wage Cuts Necessary but Difficult

Paul Krugman discusses the problem facing those EMU member countries that are currently suffering from a lack of competitiveness (note, by the way, his use of the word competitive!) and accepts that nominal wage reductions are a necessary part of the adjustment: you can read his discussion here.

He also links to a posting by Edward Hugh that probes the difficulties involved in engineering nominal wage reductions: you can read it here.

4 replies on “Krugman: Nominal Wage Cuts Necessary but Difficult”

It might be easier to achieve wage cuts if they were attached to an EU sponsored fiscal stimulus package – or even a precondition for the retention of our preferential tax rates. However, lower nominal wages is going to mean a lot of unpaid mortgages, repossessions, etc.!

I think the point of lower nominal wages resulting in greater repossessions etc is greatly overdone. First, mortgage repayments have been the primary driver of lower inflation, so those with the greatest mortgage debt have the lowest inflation (e.g. someone on €60k with a recent €200k mortgage currently has a personal inflation rate of around -7%). Second, a 5% nominal cut in disposable income has the same effect as a 25 bps rise in interest rates in terms of the share of mortgage repayments in income – unwelcome, but not huge. The great threat to mortgage holders is unemployment, so nominal wage adjustment will be more of a help than a hindrance in terms of controlling delinquency rates.

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