Eurozone Asymmetries

Suppose a large Eurozone set down – let’s telephone telephone it French Republic - decided that it needs to substantially increment its minimum wage inwards guild to trim down poverty. The increment is sufficiently large that it leads to a sustained increment inwards average French wage inflation, which inwards plough decreases the competitiveness of French Republic relative to the relaxation of the Eurozone. French Republic cannot survive permanently uncompetitive, too thence the obvious trial would survive that French Republic has to suffer a subsequent menstruum inwards which its relative inflation was below the Eurozone average.

However this would require a menstruum where French unemployment was higher upward its natural rate. French politicians declare that this would survive politically unacceptable to French voters. Instead they propose French inflation should rest at 2%, too the residual of the Eurozone should increment their inflation charge per unit of measurement to 4% for a fourth dimension (giving an average Eurozone inflation charge per unit of measurement of over 3%) to ensure French Republic regains competitiveness. Now this would non usually survive possible, because the ECB’s inflation target is 2%. However the influence of French Republic on the ECB is such that the ECB fails to enhance involvement rates inwards fourth dimension to forbid 3% average inflation, too afterwards keeps involvement rates depression because they repeatedly forecast inflation falling dorsum downwards to 2% inwards due course.

The relaxation of the Eurozone would understandably survive upset at having to suffer 4% inflation. Some countries mightiness propose that perhaps, inwards the absence of ECB action, they could tighten financial policy to instruct their inflation below 4%. However French Republic refuses to countenance changes to agreed financial targets, too instead suggests that what is actually required is for other countries to adopt a like increment inwards the minimum wage to the 1 originally undertaken inwards France. The French caput of the ECB gives a speech communication where he intimates that the ECB mightiness survive prepared to enhance involvement rates a footling fleck inwards telephone commutation for other countries introducing this ‘structural reform’ to their minimum wage levels. The French regime also hints that it mightiness survive prepared to allow really express financial contraction exterior of France, simply exclusively if this took the shape of taxation increases rather than populace expenditure cuts.

Your reaction to this footling imaginary story is that it couldn’t peradventure occur because other Eurozone countries would non permit it to happen. My proposition is that Federal Republic of Federal Republic of Germany rather than French Republic is doing just this at the moment, except that inwards their illustration it started amongst a menstruum where High German wage inflation was below the Eurozone average (for reasons discussed past times Dustmann et al here). [1] High German command of the ECB mightiness non survive every bit consummate too unproblematic every bit I imagined French influence inwards the story above, simply it has the payoff that involvement rates receive got hitting the cipher lower bound, too the threat that anything unconventional could survive declared illegal. And inwards this existent basis story I also wonder why other Eurozone countries allow Federal Republic of Federal Republic of Germany to instruct away amongst it.

[1] In fact what Federal Republic of Federal Republic of Germany is doing is worse, because inflation asymmetries too debt deflation mean that the output costs of achieving cipher inflation exterior Federal Republic of Federal Republic of Germany to find non-German competitiveness are far greater than the costs associated amongst 4% inflation inwards my story.