SEB - Skandinaviska Enskilda Banken AB

10/30/2020 | Press release | Distributed by Public on 10/30/2020 04:57

Economic Insights – Sweden’s wage round, in the shadow of the pandemic

A bit away from the spotlight, the national wage round resumed in early October, with the high ambition that industrial employers and unions should reach agreement before the end of the month. After unions last week rejected a mediation proposal including pay increases totalling 4.5 per cent by the end of March 2023, it appears uncertain whether the two sides will succeed. Yet we believe that within the near future, we will see an industrial agreement with pay hikes of around 5 per cent covering the same period. This contract will then serve as a benchmark for the rest of the labour market, although the Municipal Workers may win a slightly higher increase. This would represent a slowdown in the rate of pay hikes. In its forecasts, the Riksbank has already acknowledged that it will take a long time before its 2 per cent inflation target can be achieved. The question now is whether the bank can gain acceptance for a more cautious key interest rate policy, or whether long-term inflation expectations will fall even further below target. If so, we may end up in a situation similar to 2012-2014, when labour market organisations were among those accusing the Riksbank of not taking its own target seriously, thus undermining its role as a wage formation 'anchor'.

Since it resumed on October 1 − after being interrupted by the COVID-19 outbreak - the national wage round has maintained a rapid pace. Its aim is to achieve an industrial collective agreement by the end of October. The two sides thus immediately sought the assistance of a group of 'impartial negotiation leaders' (OPO). The previous industrial sector agreement expired on March 31, 2020, which means the two sides must also sort out a no-deal period of 7 months. Both sides declared at the start that they wanted a relatively long-running agreement. On October 20, the OPO group unveiled its first proposal to both sides, including a 4.5 per cent pay hike by the end of March 2023. This closing date restores the rhythm established many years ago. The proposed pact thus runs for 29 months, but since it includes no retroactive pay hikes it can also be interpreted as a 3-year agreement. The employers and unions were given only 24 hours to evaluate the proposal. The employers accepted it, noting that it represented a 'pain threshold', but the union side rejected it as too low.

Timetable for the interrupted 2020 wage round

Oct-Nov 2019: Union coordination discussions

Jan-Feb 2020: The two sides began negotiations

March 2020: Talks are suspended due to the pandemic

March 31, 2020: Agreements expire for 1.3 million employees in industry and other sectors

April 30, 2020: Agreements expire for about 0.5 million employees in construction and other sectors

October 2020: Negotiations in the industrial sector resume

Nov-Dec 2020: Negotiations in other private sectors

Jan-Feb 2021: Negotiations in the public sector

A new OPO proposal is likely within the next few days, and most indications are that the two sides can agree on it. We believe it will end up including total pay hikes of around 5 per cent for the entire contractual period. It is clear that the pandemic is a very important factor behind this level. Last autumn, ahead of the wage round, the industrial unions demanded yearly pay increases of 3.0 per cent. This was somewhat higher than their 2.8 per cent demand ahead of the 2017 wage round, which ended with a 3-year agreement incorporating yearly pay increases of 2.1-2.2 per cent. Today it instead appears that pay hikes will slow down, regardless of whether the proposed increases are spread over 29 or 36 months. Once the industrial sector agreement is signed, it will be time to resume negotiations in other sectors. No major divergences from the 'industrial sector norm' are expected. As a result of the union coordination discussions a year ago, most unions supported the demands of the industrial unions. This will undoubtedly apply now as well, but the largest union in the Trade Union Confederation (LO) - the Municipal Workers - chose to follow its own path last autumn when it failed to gain acceptance for special demands on behalf of various employees with vocational training, such as nursing assistants. The Municipal Workers withdrew from the union coordination discussions and will probably succeed in winning slightly higher pay hikes than other unions, since certain public sector labour shortages have been further accentuated during the pandemic.

Forecasts of wage and salary increases

Year-on-year percentage change

2019

2020

2021

2022

Riksbank, KL, Sep

2.6

1.7

2.3

2.7

Nat'l Institute of Econ. Research, KL, Sep

2.6

1.9

2.2

2.5

SEB KL

2.6

1.5

2.2

2.5

Riksbank, NR, Sep

3.9

4.3

0.4

2.5

NIER, NR (Business), Sep

3.9

5.2

-0.8

2.4

Source: Statistics Sweden, Riksbank, NIER, SEB

The pandemic creates measuring problems. What, then, do these agreements mean to general price and wage formation? It is clear that actual hourly wage and salary increases are hard to measure in a situation where pandemic relief programmes such as short-time subsidies affect working hours. The wage concept used in the National Accounts (Nationalräkenskaperna, NR) is based on actual hours worked, while the statistics series known as Konjunkturlönestatistiken (KL) is based on planned or contractual working hours. As the table and chart show, the differences between these definitions are currently sizeable. We believe that the KL metric is more relevant for assessing the underlying trend. For example, the NR metric exaggerates unit labour costs for companies this year, since they are being compensated via government subsidies. But as the forecast table above indicates, the differences between these metrics are only temporary. Cumulatively during the full years 2020 and 2021, the rate of increase is similar. Our own current estimate is that the Riksbank's forecast of an acceleration in the rate of pay increases to 2.7 per cent in 2022 is slightly too aggressive. In any case, all indications are that we will now see pay agreements that will cause the rate of wage and salary increases well into the future to be lower than is compatible with the Riksbank's inflation target. In the long term, yearly pay increases of 3.5 per cent are regarded as consistent with the target, but in the current situation of relatively weak productivity growth, the level may be somewhat lower. According to the latest NIER report, CPIF inflation (the consumer price index less interest rate changes) will reach 2 per cent in 2023 when wages and salaries increase by 3.2 per cent.

In its latest Monetary Policy Report, the Riksbank insisted that key interest rate cuts are not being considered in the near term. But the central bank added that 'the repo rate can also be cut if this is assessed to be an effective measure, particularly if confidence in the inflation target were to be threatened.' Since both effectiveness and confidence in the inflation target can be linked in various ways to wage formation, there is reason to look a little more closely at the interplay and the relationship between monetary policy and wage formation. Stylising a bit, we can distinguish a few different periods ('regimes') that have dominated the relationship between the Riksbank and the two sides in the labour market over the past few decades.

Regime 1: Riksbank admonitions about 'responsibly' low pay hikes. For a long time, the Riksbank maintained a high profile in terms of trying to influence wage formation. When the macroeconomic framework featuring floating exchange rates and inflation targets was introduced in the 1990s, it was important to establish the credibility of the inflation target, so that the rate of pay increases could decelerate after decades of high levels. Despite relatively high unemployment, the first national wage round under the new framework resulted in pay increases in the range of 5-6 per cent. The process industry was the first to sign an agreement at this high level. It is a sector characterised by especially high capital-intensity and is thus less sensitive to pay increases, especially in the then-prevailing environment, where a weak krona drove up profit levels. The conclusion was that sector-by-sector negotiations as such were unfortunate, but also that the timing of these negotiations was important. This experience soon led to the 1997 Agreement on Industrial Development and Wage Formation (Industry Agreement), which has subsequently had a major influence on wage formation. Up until 2010-2011, the Riksbank - albeit with varying intensity - rather actively tried to admonish the employer organisations and unions not to agree on excessively high pay increases. In addition, during this period the NIER's Wage Formation Report had the ambition of specifying in detail how much room for pay hikes the two sides would have.

Regime 2: The two sides in the labour market criticise the Riksbank for neglecting its inflation target. Over time, however, the employer organisations and labour unions became increasingly irritated by these direct attempts to intervene in wage formation. During 2012-2014 the relationship between the Riksbank and these organisations also changed for other reasons. After the key interest rate hikes of 2010-2011, the krona appreciated sharply, which contributed to falling inflation, and during the period 2012-2014 CPIF inflation averaged around 1 per cent. Although the Riksbank lowered its repo rate, it remained well above key interest rates set by the US Federal Reserve, the European Central Bank and others. The Riksbank justified its half-hearted efforts to push up inflation, more or less explicitly, by saying that it wanted to slow the upturn in home prices and household debts. Aside from low actual inflation, this 'lean against the wind' policy also contributed to falling inflation expectations. In this situation, the employer organisations and unions concurred in their sharp criticism that the Riksbank's lack of interest in meeting the inflation target made it impossible to use this target as an 'anchor' for wage formation.

Regime 3: Criticism of the Riklsbank for krona volatility and exaggerated eagerness to reach the inflation target. The most intensive criticism by employer organisations and unions coincided with the Swedish government's decision to give the Financial Supervisory Authority (FSA) the main responsibility for macroprudential oversight, which decreased the legitimacy of the Riksbank's 'leaning against the wind'. There were thus dual motives behind the Riksbank's shift towards a full commitment to pushing up inflation, which began with a 50 basis point repo rate cut in July 2014. After this policy shift, the inflation expectations of the two sides clearly moved higher, although this was certainly also due to other factors. They needed a long time to become convinced, but the union side was prepared to again embrace the inflation target as an anchor when it established its guidelines for the national wage round in the autumn of 2019. But the employer organisations disassociated themselves from the prevailing framework, also for reasons of principle. They were not only critical of the Riksbank's way of conducting its monetary policy, but also stated with increasing clarity that its inflation targeting policy is not appropriate. During 2018 and 2019, business sector representatives also repeatedly criticised the Riksbank for being too fundamentalist about fulfilling the inflation target. This included criticising the central bank for ignoring such negative side effects as exchange rate volatility and the bargain prices of Swedish assets. Although the connections are not obvious, it is worth noting that the period after the 1992 krona collapse led to significant change in the ownership of the Swedish business sector, with a wave of head office out-migrations as a result.

New problems with falling inflation expectations. These three 'regimes' can serve as background when speculating on various conceivable future trajectories. It is not so strange that the Riksbank has now chosen to publish a price and wage forecast in which it confesses that it will be difficult to achieve its inflation target within a 3-year horizon (see chart below). If the central bank had acted differently, it would have exposed itself to criticism for making unrealistic forecasts and perhaps also for indirectly trying to influence the wage round. The problem that may instead now arise is that inflation expectations will slowly decline from the 2 per cent target. We may then once again end up in a 'regime 2' situation, with employer organisations and unions blaming the Riksbank for not taking its own inflation target seriously. We have already seen indications that at least leading economists on the employer side are postulating that not even the Riksbank itself believes any longer that its inflation target can be fulfilled.

Honesty seems to have its price. The Riksbank's more realistic price and wage forecasts may contribute to falling inflation expectations, which is a dilemma that we should be aware of when interpreting its Executive Board's future communications. Although different Board members have expressed varying levels of conviction on the matter, right now the threshold seems very high for re-introducing repo rates below zero per cent. This is undoubtedly because they generally take the negative side effects more seriously and, in particular, see the limitations of a strategy of using a weak krona as an inflation generator. Further repo rate cuts are especially ineffective in a situation where pandemic-related restrictions are hampering economic activity, a circumstance that strengthens these arguments further. But if inflation expectations fall, the Riksbank will be subjected to pressure from different directions. Even if real interest rates remain low in historical terms, one can argue that they will be pushed upward from two directions if the Riksbank keeps interest rates higher than necessary at the same time as inflation expectations are drifting downward. Once pandemic-related restrictions are relaxed and we enter a more normal recession environment, this will also weaken the argument that the interest rate weapon is ineffective. At least mainstream academic economists will emphasise that an unnecessarily high real interest rate will then hamper growth.

What can the Riksbank do to maintain inflation expectations? To begin with, the Riksbank has everything to gain from not closing the door to negative key rates. Instead, it may be justified in signalling a slightly 'exaggerated' probability of negative interest rates, even if it actually considers this repulsive to actually have to deliver. Increased asset purchases (QE) remain one way to keep up monetary stimulus, although this also has some negative side effects, and bond shortages will soon become apparent. Additional QE may be an appropriate signal to the government and Parliament that the Riksbank will indeed ensure persistently low interest rates, provided that fiscal policy makers assume the main responsibility for stimulus measures in the recovery phase. Inspiration from changes in the structure of American monetary policy may also play a role. The Federal Reserve has been given greater flexibility to accept overheating tendencies in the labour market and allow inflation to exceed the Fed target for a period, as compensation for earlier shortfalls. This has contributed to rising inflation expectations, at least according to pricing in the inflation-linked bond market. In slightly looser terms, the Riksbank has also already signalled its acceptance of a period of above-target inflation, after a long period of below-target average inflation. Yet it is still doubtful whether this type of not particularly binding commitment is really enough to keep inflation expectations up. Looking ahead, it is conceivable that the Riksbank can somewhat more formally design principles for symmetrical target fulfilment over time. However, it should be recalled that not long ago, a parliamentary commission of inquiry on the Riksbank proposed restrictions on the central bank's freedom of action. Although this proposal has been heavily criticised and is perhaps no longer relevant, it is still worth noting that the commission was widely criticised for not wanting to give the Riksbank greater freedom to more permanently fall short of its inflation target.

A strong krona may be a problem in the long run. The views of the employer and employee sides on the role of the exchange rate are complex and have varied a bit over time. In general, they have agreed not to let short-term currency fluctuations affect their analysis of the room for pay increases. During 2012-2014 ('regime 2'), however, it was clear that they perceived the strong krona - with an EUR/SEK exchange rate well below 9 − as a problematic side effect of the Riksbank's inclination to 'lean against the wind' and keep interest rates higher than necessary. Even though the competition aspect was closest to their hearts, they could also argue that this pushed inflation downward. It is likely that their criticism of the Riksbank will become more intensive if the krona appreciates significantly. Since 2014, the EUR/SEK equilibrium exchange rate has moved upward, so the pain threshold is probably higher than before. But from today's levels of around 10.50, we probably still have a long way to go before the strength of the krona is perceived as problematic. In our latest 'SEK Views' in October, we presented a scenario in which the EUR/SEK rate drops to 9.65 (and the USD/SEK rate to 7.70). In this situation, CPIF would end up well below the Riksbank's forecast, mainly staying under 1 per cent until the end of 2022. In such a scenario, it is reasonable to believe that the Riksbank, urged on by the employers and unions, would lower the repo rate to negative levels of around -0.50 per cent.

Is more at stake in Sweden than elsewhere? To summarise, the COVID-19 crisis combined with the fact that employer organisations and unions are about to sign relatively long-term collective agreements including modest pay increases have caused the Riksbank to change its strategy. The central bank now admits that it will take a long time to reach its inflation target, and it is difficult for us to avoid the impression that the Riksbank is willing to show greater tolerance for low inflation in the prevailing environment. As a result, the relationship between the two sides in the labour market and the Riksbank is entering a new phase. What shape it assumes will affect the Riksbank's future manoeuvring room. If the long-term inflation expectations of the employer organisations and unions are allowed to shift further and further away from the 2 per cent target, the entire macroeconomic framework may begin to come under question. This should strengthen the employer side's increasingly clear argument that the inflation target has also become irrelevant in principle. But as long as Swedish public opinion strongly rejects joining the euro area, it is not so easy to see any reasonable alternative. This implies that there is perhaps more at stake in Sweden than in other countries, although the Riksbank is far from alone in fighting troublingly low inflation. In this case, it would follow a historical pattern of greater tensions surrounding the macroeconomic framework in Sweden than in many other countries. This, in turn, is probably due to the tendency of the various actors to over-dramatise its various consequences.