Wage-setting and inflation targets in EMU

Although the operation of national coordinated wage-bargaining systems in EMU has produced low inflation rates, EMU-wide inflation has been above the ECB target rate for the last 3 years. By contrast, under the ERM, inflation rates declined steadily after 1992 to below 2 per cent in both the last 2 years of the regime. It is argued that this was the consequence of two low-inflation incentives under ERM: (i) the Maastricht inflation condition for EMU entry; and (ii) the combination of the Bundesbank threat to raise interest rates if German wage and price inflation rose above acceptable limits, linked to the need for other ERM members to follow low German inflation to stay within the exchange-rate bands. These incentives no longer operate under EMU, where individual economies do not have an incentive to contribute to low EMU-wide inflation. We suggest that inflation coordination between the large EMU member states might contribute to a solution while permitting the continuation of real exchange-rate adjustments of smaller economies.

Duke Scholars

Author David Soskice Political Science