Should workers alone reduce inflation?

The idea of the Union Alliance regarding the reduction of inflation and interest rates is that everyone contributes to a long-term contract (for three or four years). Companies lower the prices of necessities, banks and pension funds lower interest rates on housing loans, and the public sector moderates tariff increases. It is also expected that the government fulfills the promise it made when signing the Living Wage Agreements (Lífskjarasamninginn) 2019 to put a brake on apartment rent increases. It also fights inflation.

To achieve this goal the unions stepped forward and offered unusually modest wage increases to ease cost increases of companies shoulders and create more room for price cuts. Instead, the government was asked to rebuild the public redistribution transfer system, which has deteriorated significantly in the last years and decades.

The compensation should thus be applied from sources other than primarily wage increases, i.e. in the strengthening of the public transfer systems and from a reduction of inflation and interest rates. This plan was put forward and sought to be implemented in negotiations with the Confederation of Employers (SA).

Employers want everything for nothing

SA’s response to the moderate wage demands of the labor movement was to reduce wage increases even more, by a margin. The unions have now accommodated it, because of their strong will to make the plan work. But there is a limit to how much you can give in. The companies’ contribution has to be more than empty words.

The union’s idea also included setting criteria for an acceptable reduction in inflation and interest rates in the coming years (red line, as used in the national reconciliation agreements (Þjóðarsáttin) of 1990). If inflation were to exceed these targets, wage supplements would be paid to workers, the higher the further inflation was from the target. This would not be a full wage guarantee, but still, be enough to give the companies an incentive to stay within the inflation target. This is both fair and sensible to do.

If inflation were to exceed 7% in the second quarter of 2025, i.e. higher than it is now, then the contract would be terminable, since it is clear that the experiment had completely failed. However, given the central bank’s latest inflation forecast and the state of the economy in general, there is a negligible chance that these insu prerequisite clauses will be put to the test. 

The companies raise prices, not workers. In the companies, there is a persistent temptation to raise prices beyond cost increases to increase profits (as happened in 2021 to 2023 – see here). It is a much easier way than increasing profits through productivity increases and optimizations. These temptations to excessive price increases are precisely one of the reasons why Iceland has the highest price level in the world since there is generally little competitive restraint in Icelandic business life.

Interest rates have to decrease

The same strategy was implemented by The Union Alliance regarding the reduction of interest rates, i.e. to set a quantifiable goal and authorize revision or termination of the contracts if the result would be significantly below expectations. However, it was assumed that the reduction in interest rates would not be as fast as the reduction in inflation.

Interest rate reduction must cover both nominal and real interest rates. Real mortgage interest rates have long been much higher in this country than in neighboring countries. Today, the real interest rate on indexed mortgages is close to 4%, but should generally not be higher than 2-2.5%. In Denmark, they are now around or below 1%.

SA completely rejects the prerequisite clauses put forward by The Union Alliance connected to the reduction of inflation and interest rates, except in such a watered-down form that it results in nothing. They do not want any active control over the pricing of companies and do not set any real targets for lowering interest rates, with authorization for real compensation or termination of the contracts if the result is far from the targets. They call it an attack on the central bank’s independence, which is absurd, as the central bank continues to have full freedom to set interest rates as it sees fit.

National agreement on increased profits for companies and banks?

The issue is that workers must have real guarantees about further wage increases and escape routes if the companies, banks, and others do not deliver, which was supposed to be a joint effort. Without active insurance, it is not possible to enter into a long-term contract. The National Settlement Agreements of the 1990s had real insurance provisions for workers, much stronger than SA claims to accept now.

Without such insurance, the project turns into a national agreement for workers to bring down inflation without the companies and the financial system making any significant contribution. This will then be “a national agreement on moderation and responsibility for workers and big profits for companies and banks!”

The author is a professor emeritus at the University of Iceland and an expert at Efling.

The article was first published on Heimildin on February 12, 2024.