Three possible scenarios to stem the decline in purchasing power – Natixis

In the United States and the eurozone, wages are now rising much less than prices. Economists at Natixis believe that the resulting loss of purchasing power is unsustainable cannot continue. There are then three possible scenarios to stabilise purchasing power.

Public transfer payments

“Wage growth remains low and inflation remains high. Wage-earners, therefore, do not obtain any improvement in their bargaining power, and monetary policy does not combat inflation effectively. In this first scenario, purchasing power is supported by public transfer payments to households. This policy’s limit is obviously its high cost for public finances if they have to bear the full cost of the increase in commodity prices.”

Restrictive monetary policy

“Wage growth remains low, but central banks drive down inflation with a sufficiently restrictive monetary policy. It is a fall in inflation obtained thanks to higher interest rates that gives purchasing power back to wage earners. The problem with this strategy is that to obtain a significant fall in inflation, it requires a markedly higher rise in interest rates than is currently expected The risk with this strategy obviously relates to the significant rise in interest rates: higher borrowing costs for governments, leading to more restrictive fiscal policies; collapse in asset prices; fall in investment and growth.”

Wage re-indexation

“Inflation remains high, as monetary policy remains not very restrictive, and purchasing power is protected by a re-indexation of wages to prices. The risk with this strategy is clear: if wages track prices perfectly and if prices track labour costs perfectly, equilibrium inflation after an inflationary shock becomes very high, as was seen in the early 1980s.”