Ulrike Malmendier: "It is amazing that wages are not rising more dynamically in a time of labor shortages"
Jun 2023
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A star of the guild
Since becoming a member of the German Council of Economic Experts, also known as the "Wirtschaftsweise", Ulrike Malmendier has been a star of the German economists' guild, partly because of her illustrious career in the USA. In an interview with NZZ, the UBS Center Advisory Board member explains why inflation is so high and whether a wage-price spiral is looming. Moreover, she states that the government's 2030 electricity targets are unrealistic.
This interview by René Höltschi and Michael Rasch was originally published in German in Swiss daily NZZ on 29 April 2023. Translated and edited for layout purposes by the UBS Center.
Ms. Malmendier, we now have the highest inflation rates in Germany and in Europe in decades. Inflation had already picked up before the outbreak of the Ukraine war and the resulting explosion in energy prices. What were the reasons for this?
You speak from my heart. The increase in inflation from even before the Russian war of aggression is usually overlooked. Inflation had already picked up in 2021, especially in core inflation, which does not include volatile energy and food prices. In my adopted country, the U.S., it is rightly argued that generous fiscal stimulus by the government in response to the Corona crisis played a role, and that Europe partly imported the incipient inflation. Moreover, there were also substantial increases in government spending in Europe as a result of the pandemic. The U.S. Federal Reserve (Fed) and the European Central Bank (ECB) were late in responding to rising inflation and have long spoken of a temporary inflation effect. However, I must also admit that I was then pleasantly surprised by the ECB's hefty interest rate hikes.
Why did the central banks react so late? Did they not want to see the danger, according to the motto "what can't be, can't be"?
That may have played a role. It was probably also important that very low inflation was real life for a long time, among people in general and also among central bankers. That settles in the mind and promotes the expectation that everything will stay that way. That's exactly my area of research. Personal experience plays a huge role in expectations. To that extent, I really believe that there is some truth in the phrase "What hasn't been for a long time cannot exist," in terms of thinking and expectations. But of course, if you break it down to the different camps, you have to say, the proponents of loose monetary policy in particular did not want to acknowledge rising inflation for a long time.
You once said elsewhere that the ECB's task is more difficult than that of the Fed because the ECB always has to hold the eurozone together as well. Isn't that the task of politics, which the ECB has then taken on?
Quite clearly, the ECB's mandate is solely monetary stability. However, Greece showed us how quickly a breakup of the euro zone can become a real danger. In my opinion, it would be unrealistic to think that this does not play a role in the back of the central bankers' minds.
In the meantime, headline inflation has come down a bit, but core inflation continues to rise. How great do you think the risk is that headline inflation will remain above the ECB's target of 2 percent for longer?
There are studies that argue that it takes at least six to twelve months for higher interest rates to have a dampening effect on inflation. That's why the ECB's late reaction was unfortunate, and why exaggerated expectations of immediate effects are now misplaced. The naïve idea that interest rates will rise and inflation will fall next month is wrong.
In Germany, trade unions have already presented wage demands of 10 percent and more. Do you see the danger of a wage-price spiral?
From a completely mechanistic point of view: yes. If wage increases exceed annual inflation by six to seven percent, there is a risk of a wage-price spiral. So far, however, wage growth has lagged behind inflation, at least in Germany. In my opinion, this will still be the case in 2023. But of course it doesn't have to stay that way. The question is how long employees will continue to accept real wage losses.
Do you expect a phase in which employees will get a larger share of corporate profits than in past decades because of the labor shortage?
Yes, that would be very plausible. It is astonishing that wages do not rise more dynamically in a period of labor shortage. Moreover, I don't yet have an answer to why this hasn't happened so far.
The collapse of Silicon Valley Bank and the distress sale of Credit Suisse have made the banking crisis an issue again. Were these isolated incidents, or is more trouble looming?
Credit Suisse was a special case, although the fact that financial market participants were very nervous at the time obviously played a role. As far as the U.S. is concerned, we're back to the issue of experience effects. Silicon Valley Bank was very poorly prepared for rising interest rates. Unfortunately, this phenomenon affects quite a few banks. However, as long as there are not any bank runs, there should not be a systemic banking crisis.
Did the regulators also fail?
They were part of the problem. In Europe, for example, it has been too long since a stress test assessed the consequences of sharply rising interest rates. There was too much focus on very low interest rates.
In the U.S., regulation for small and medium-sized banks had also been relaxed.
This is true, but according to our calculations it was not causal for the current problem. However, the relaxation is a symbol that regulators did not expect serious problems in this segment.
After the financial crisis, regulators wanted to make banks safer and be able to wind them down in an emergency, the keyword being "too big to fail." But in the first major case, Switzerland threw this noble intention overboard and orchestrated a state rescue of Credit Suisse. What was your opinion?
This is taken for granted in the U.S. There, the authorities act pragmatically. It's true that there was a bit more regulation and supervision there after the financial crisis. But it is an open secret that some banks remain "too big to fail" and must be rescued by the state in an emergency.
So it's illusory to protect taxpayers from bank failures?
Ex ante, we can say that we are trying to minimize the risk, for example with high capital requirements and strict stress tests. But if it does happen, the banks have to be rescued to prevent very serious economic damage. That's the lesson we learned from the demise of Lehman Brothers.
What did you learn from the Silicon Valley Bank case?
For me, what was interesting and important was that not enough consideration was given to the nature of the customers and their interconnectedness. The customers were primarily Silicon Valley startups that communicate with each other and then heard from their backer Peter Thiel that things were looking very critical at the bank. They then reacted almost simultaneously and withdrew funds. This case has not happened for a long time either, and people acted too strongly based on recent experience - this applies to bankers and supervisors alike.
Let's look at Germany. In terms of growth, the country is one of the laggards among the industrialized nations. Why is that?
The other industrialized countries are also experiencing modest growth. Growth is better in the USA, but we are concerned about the financial market risks there. At present, China and the rest of Asia in particular are doing relatively well now that the pandemic has subsided. Germany is very intertwined economically and has therefore suffered particularly from the Corona-related shutdowns in Asia. We have also been hit hard by the high energy prices. We are, after all, an industry-intensive country, and our energy-intensive industries are also important. And the fact that inflation has been on the rise for a year and a half hasn't helped.
Is the fear of Germany's deindustrialization therefore justified?
For me, deindustrialization is too ambitious a word. At the moment, I don't see Germany ceasing to be an industrial nation as a result of all these factors. The country still has a lot to offer in terms of human capital, infrastructure, as well as its legal and social systems. However, this does not mean that the industry does not need to restructure. I would have liked us to see more of the opportunity in the crisis instead of clinging to what we have. Why did Elon Musk have to come along first to revolutionize the auto industry with e-cars and autonomous driving, why didn't that happen in the car country Germany? We have held on to the internal combustion engine for too long, because it generated a lot of profit.
The American Inflation Reduction Act, the IRA, has contributed to the fear of an exodus of industry.
At the beginning, Europe overreacted a bit. According to our calculations, the impact is not that big. We should also celebrate a little that the Americans are doing something for the environment and the climate. In the EU Commission's move with the Zero Industry Act as a response to the IRA and in the direction taken by the EU, I see more of a danger of a subsidy race. In Europe, we already subsidize a lot anyway, perhaps more than the US. We should see opportunities for us in the IRA and ask ourselves where we have competitive advantages that we can use as a close trading partner of the U.S. - such as environmental technologies.
Germany shut down the last nuclear power plants and wants to stop generating electricity from coal by 2030 if possible. Electricity is to be generated primarily with renewable energies, supplemented by gas or hydrogen power plants. Is that realistic?
First of all, I would give the government credit for making this an issue and giving figures against which it can be measured. The goal of generating 80 percent of gross electricity consumption with renewable energies by 2030 is no longer achievable from today's perspective. I do have some hope that some of the recent successes in accelerating planning procedures can be transferred and that the expansion of renewables can be speeded up a bit as a result. But from today's perspective, the original goal is not achievable. Nevertheless, it can be good to set clear targets and clear measures. At least the industry will then know what it is getting into.
The governing coalition known as the “traffic light” due to the colors of its participating parties has presented a draft law that is supposed to initiate the "heat turnaround" with very detailed specifications for heating systems. Wouldn't it be better to rely on rising CO2 prices, which would discourage oil and gas as heating fuels anyway?
My basic reaction as an economist is, of course, let's use the price. But sometimes it also needs a nudge out of the old equilibrium, for example with the announcement: This simply won't work now with gas powered heating systems. But an announcement can speed things up. If we focus only on price and emissions trading, there is also a real risk that politicians will change the rules in their bid for votes when things get expensive. In this respect, I am not as fiercely opposed to bans as you might have expected me to be as a price- and market-oriented economist.
As a German economist, you teach and live in the USA. What could Germany learn from the U.S. in terms of policy advice - and vice versa?
The Americans traditionally do one thing very well: When a new government comes into office, it brings in the best people from the best universities for the topics that are important at the time. And they immediately agree; it's part of their duty to the community and an honor to do something like that. We don't have that tradition: there are scientists who are more on the policy advisory track, and others who are on the scientific track. The real top economists in Germany are traditionally not particularly close to the political consulting track. But I think that's changing a bit right now, and the executive branch of the government is also looking more actively for advice. However, I have come to appreciate that we have an institution in Germany, the German Council of Economic Experts, which is not answerable to the chancellor, and which can also criticize the government. Something like that might also do the U.S. some good.
What is the solution?
In the meantime, I think we need both: on the one hand, something like the American Council of Economic Advisors, which reports to the president. In Germany, this would mean having a top economist in the Chancellor's Office, in the Economics Ministry, and in the Finance Ministry. On the other hand, the independent Council of Economic Experts would continue to exist.
Since becoming a member of the German Council of Economic Experts, also known as the "Wirtschaftsweise", Ulrike Malmendier has been a star of the German economists' guild, partly because of her illustrious career in the USA. In an interview with NZZ, the UBS Center Advisory Board member explains why inflation is so high and whether a wage-price spiral is looming. Moreover, she states that the government's 2030 electricity targets are unrealistic.
This interview by René Höltschi and Michael Rasch was originally published in German in Swiss daily NZZ on 29 April 2023. Translated and edited for layout purposes by the UBS Center.
Ms. Malmendier, we now have the highest inflation rates in Germany and in Europe in decades. Inflation had already picked up before the outbreak of the Ukraine war and the resulting explosion in energy prices. What were the reasons for this?
Ulrike Malmendier is the Edward J. and Mollie Arnold Professor of Finance at the University of California at Berkeley, Professor of Economics in the Department of Economics, and Professor of Finance at the Haas School of Business. She has been a member of the German Council of Economic Experts since September 2022. Malmendier is also serving on the UBS Center Advisory Board. (Image: Sachverständigenrat Wirtschaft)
Ulrike Malmendier on Google Scholarbrowse
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Ulrike Malmendier is the Edward J. and Mollie Arnold Professor of Finance at the Haas School of Business and Professor of Economics at the University of California. Her research interests are corporate finance, behavioral economics/behavioral finance, economics of organizations, contract theory, law and economics, law and finance. In 2013, Malmendier was awarded the prestigious Fisher Black Prize from the American Finance Association, given biennially to the top financial scholar under the age of 40. She has been a member of the German Council of Economic Experts since September 2022.
Ulrike Malmendier is the Edward J. and Mollie Arnold Professor of Finance at the Haas School of Business and Professor of Economics at the University of California. Her research interests are corporate finance, behavioral economics/behavioral finance, economics of organizations, contract theory, law and economics, law and finance. In 2013, Malmendier was awarded the prestigious Fisher Black Prize from the American Finance Association, given biennially to the top financial scholar under the age of 40. She has been a member of the German Council of Economic Experts since September 2022.