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The labour market will continue to drag down inflation in the Eurozone

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Market expectations on ECB policy radically changed after Mario Draghi's Jackson Hole speech in August 2014. In May, Draghi revisited the same themes, particularly the risks inherent in the transformation of cyclical unemployment into structural unemployment.

A detailed study of labour market conditions in the eurozone shows that it is still in bad shape. Long-term unemployment is very high and is not showing any real signs of improvement. Involuntary part-time work has soared in Italy and Spain. Overall, the labour market will prevent inflation from growing rapidly in the eurozone. Moreover the divergence between Germany and the other major eurozone countries haswidened.

 

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For ECB watchers, the game changed when Mario Draghi spoke at the Jackson Hole symposium in August 2014 (his speech was entitled "Unemployment in the euro area"), where he strongly emphasised the risk that the rise of long-term unemployment represented for medium and long-term inflation outlooks. This speech led to expectations of a QE policy: "The risks of 'doing too little' – i.e. that cyclical unemployment becomes structural – outweigh those of 'doing too much' – that is, excessive upward wage and price pressures."

Amid the Greek saga, Draghi's speech of 22 May ("Structural reforms, inflation and monetary policy") went somewhat unnoticed. However, the ECB president revisited the themes of his Jackson Hole speech. He emphasised the fact that "a cyclical recovery alone does not solve all of Europe’s problems" and that "it does not eliminate the debt overhang" of governments, nor "the high level of structural unemployment that haunts too many countries." Draghi noted that low potential growth in the eurozone (international institutions put it at below 1%) is partly due to hysteresis effects and the transformation of cyclical unemployment into structural unemployment. We therefore see an opportunity to assess eurozone labour market trends in detail, and that is our aim with this article.

First, it should be noted that the labour market situation varies widely from one country to the next. Unemployment is still rising or stabilising in France and Italy. It is in decline, but remains very high in Greece, Spain and Portugal. Yet it is now very low in Germany. This is a reminder that the unanimity on the ECB's Governing Council is most likely fleeting.

Second, as underscored by Draghi, it is essential to distinguish between short-term and long-term unemployment. Eurostat compiles quarterly statistics on the number of unemployed according to the duration of their unemployment. For the first time since the establishment of the eurozone,
long-term unemployment (12 months or longer) is higher than short-term unemployment. Above all, whereas short-term unemployment has been in slight decline in recent quarters, long-term unemployment is not really showing any sign of falling. For its part, very long-term unemployment (more than 24 months) continues to spread, particularly in Italy and in Spain (more than 5% and 8% of the active population, respectively). This corroborates the scenario of hysteresis effects. The long-term unemployed gradually lose their skills, and therefore their employability—a portion of cyclical unemployment may thereby potentially become structural unemployment.

Meanwhile, part-time work has grown considerably in recent years. Part-time work as a percentage of total employment has increased in major eurozone countries in recent years, particularly in Italy and Spain, although it is less widespread than in Germany. Clearly, an important question is whether workers seek out part-time work or don't have other options. Eurostat data do not detail the reasons for part-time work on a quarterly basis. But these statistics do exist on an annual basis: involuntary part-time work grew slightly over recent years across the eurozone as a whole, but again there are regional disparities. Involuntary part-time work declined slightly in Germany, but soared in Spain and Italy (approximately 65% of part-time work in these two countries, versus to 30% to 35% in 2006) and accelerated in France in 2013/2014. Growth in part-time work, and involuntary part-time work in particular, is undermining the bargaining power of employees and, by extension, their wages. This is all the more apparent given that the percentage of jobs in the services sector, where wages are usually lower, has increased dramatically in Spain (from 70.8% in 2008 to 78.2% in 2014) and to a lesser extent in Italy (from 63.9% to 72.5%).

Note that slack in the labour market is often measured by central banks as the combination of unemployment and involuntary part-time. This appears very high in the eurozone at more than 18% of the active population at the end of 2014, and is showing no real sign of decline. In contrast, it has declined significantly in the UK and in the US in recent years: slack in the labour market stood at approximately 8% of the active population before the Great Recession and now accounts for 10% of the active population, having peaked at 13% and 16%, respectively. This produced a wide lag in the economic cycles between the eurozone on one hand, and the UK and US on the other.

In contrast with the US, the participation rate did not drop in the eurozone. Rather, the number of discouraged workers—i.e., the unemployed who are not seeking work because they think it is impossible to find a new job—grew sharply in Italy (more than 10% of Italy's inactive population, versus 7% in 2008) and, to a lesser extent, in Spain.

In the end, it appears fairly clear that the eurozone labour market, although it has seen some recent improvement—is still in very bad shape, particularly compared to countries such as the US or the UK. Significant improvement is under way in Germany (less unemployment and involuntary part-time work), but the situation is still very poor in countries such as Italy and Spain, and to a lesser extent France. As a result, it is hard to believe that underlying inflationcould increase rapidly in Europe.

Low potential growth in
the eurozone is partly due
to hysteresis effects and the
transformation of cyclical
unemployment into structural
unemployment

 

2015-07-03-01

 

2015-07-03-02
2015-07-03-03
2015-07-03-04

 

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Article in English

Article en Français

Cross Asset of July-August 2015 in English

Cross Asset de Juillet - Août 2015 en Français

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DRUT Bastien , Senior Strategist at CPR AM
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The labour market will continue to drag down inflation in the Eurozone
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