This article titled “Bank’s forecasts will be vindicated, like stopped clock is right twice a day” was written by Larry Elliott Economics editor, for theguardian.com on Tuesday 2nd February 2016 19.27 UTC
Even a stopped clock is right twice a day so there will come a point when the Bank of England’s forecasts for rising wage inflation will be vindicated. But not for a while.
That’s the main conclusion of the latest paper from Danny Blanchflower and Steve Machin, which argues that the labour market will need to tighten substantially further before pay growth starts to pick up.
Here’s the background. Every quarter the Bank provides forecasts for the UK economy in its Inflation Report, and every quarter it predicts an imminent acceleration in the level of wage settlements triggered by falling unemployment. In November, the Bank pencilled in average earnings growth of 3.4% for 2016, 3.7% for 2017, 3.6% for 2018, 3.7% for 2019 and 3.9% for 2020.
The projected increase never seems to materialise, which is why on Thursday UK interest rates will be pegged at 0.5% for the 84th successive month. The next Inflation Report will also be published on Thursday and it will seek to explain why rising wage inflation has once again been delayed.
Blanchflower and Machin have consistently said that the Bank is underestimating the amount of slack in the labour market and that, as a result, the level of pay growth will continue to bump along at its current rate of about 2%. Much to the chagrin of the Bank, the two academics have been consistently right.
There can be slack in the labour market for a number of reasons. It could arise as a result of people working part time when they really want to work full time. It could be the result of former employees – say of a hairdressing salon or a plumbing firm – being laid off and then setting up their own businesses with just a handful of customers that keep them busy for a few hours a week. It could reflect the impact of an increase in the supply of labour caused by inward migration from eastern Europe, which Blanchflower and Machin believe puts a lid on wage growth.
The paper, published by the Centre for Economic Performance at the London School of Economics, pulls various factors together to come up with an estimate of under-employment in the UK, which it says has come down from a peak of 11% to just under 7%. Blanchflower and Machin estimate that wage inflation will not take off until under-employment falls below 5%, and will start to rise more sharply when under-employment is below 4%.
Two things are interesting about the paper. Firstly, it suggests that the relationship between the state of the labour market and pay is non-linear: a falling under-employment rate has little or no impact on earnings growth until a trigger point is reached. Secondly, it is a more believable assessment of what has been happening than anything the Bank has so far come up with.
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