Relevant and even prescient commentary on news, politics and the economy.

US labor market: wage and salary growth vs. payroll growth

I’ll make this quick, since I’m going to get in trouble for writing on a national holiday. But the pace of annual jobs growth is too slow to generate strong wage and salary income. Much empirical research has been dedicated to the estimation of consumption functions, generally finding that labor income is the primary driver of consumption (here’s a primer at the Federal Reserve Board). However, by extension jobs growth is highly correlated with wage and salary growth, roughly 50% of personal income – this is the relationship I analyze here.

Roughly half of the BEA’s measure of personal income comes in the form of wage and salary, so called labor income and simply referred to as ‘wages’ from here on out. This is highly correlated with nonfarm payroll growth, both in nominal and real terms (92% and 79%, respectively, since 1996). The chart below illustrates the correlation between real wage growth and nonfarm payroll since 1982 (I use real wage so as to account for the effects of inflation).

The annual pace of real wage gains and jobs growth have declined over time (jobs growth is measured using the nonfarm payroll). Simply eyeballing the data, there’s a structural shift roughly around 1996, as listed in the table below.

Using these two time periods, 1982-1995 and 1996-05/2011, I estimate a simple model of real wage growth on nonfarm payroll growth. The chart for the 1996-2011 model is illustrated below; and for reference, the regression results across both time periods are copied at the end of this post.


Note: I do not have time for a full blown econometric analysis. I did, however, perform statistical tests for serial correlation in the errors, unit roots in the transformed data (none), and general modeling tests.

I come to two general conclusions regarding the relationship between real wage growth and jobs growth over time:

(1) Real wage growth has become more persistent over time. In the first period, 1982-1995, just one lag was required to expunge the errors of autocorrelation. Spanning the second period, 1996-2011, three lags were required. The sum of the coefficients on the three lags is 0.87 in the later sample, or current wage growth is highly dependent on previous periods – sticky if you will.

(2) Nonfarm payroll growth has become less significant over time. Spanning the years 1982-1995, the coefficient on annual payroll growth was 0.27 – for each 1pps increase in the annual payroll growth, the trajectory of annual real wage growth increased by 0.27pps. The coefficient dropped to 0.17 in the sample spanning 1996-2011. This is probably a consequence of service sector jobs growing as a share of the labor market. I’d like your ideas in comments as well.

Clearly this is a very simple model but it does highlight that wages are likely stuck in the mud for some time. In May, annual real wages fell 0.6% over the year, having decelerated for 5 of the 7 months since November 2010. Real wages can pick up, but it takes time AND jobs growth faster than the 0.67% annual pace in May 2011.

Ultimately, what this analysis tells me is with wealth effects slowing markedly – the trajectory of the S&P decelerated and house prices continue to fall – it’s going to take a burst of payroll growth to get real wage and salary growth back on track enough to finance US domestic consumption. One caveat to all of this negativity is that oil prices are coming off – this will boost real wage and salary growth directly.

Rebecca Wilder
P.S. I guess this turned out somewhat less ‘quick’ than I had anticipated – not in trouble yet! Gotta go.


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State and local governments should be listed as a primary risk to the US outlook

I don’t see why the aggregate state funding gap is not numero uno on the ‘risks’ to the US outlook (I usually hear oil, Europe, China, etc., in my line of work). According to the Center on Budget and Policy Priorities, the State budget gap is not expected to clear at least through 2013. From the CBPP report “States Continue to Feel Recession’s Impact“:

Three years into states’ most severe fiscal crisis since the Great Depression, their finances are showing the clearest signs of recovery to date. States in recent months have seen stronger-than-expected revenue growth.

This is encouraging news, but very large state fiscal problems remain. The recession brought about the largest collapse in state revenues on record, and states are just beginning to recover from that collapse. As of the first quarter of 2011, revenues remained roughly 9 percent below pre-recession levels.

Consequently, even though the revenue outlook is better than it was, states still are addressing very large budget shortfalls.

Better put: state revenues are rising more quickly than expected from a low base following the most precipitous drop ‘on record’. Not feeling too confident here.


Whether or not this ‘surge’ will continue depends on the labor market, corporate profits, and retail sales – heck, aggregate demand. There’s an obvious connection between retail sales and state sales tax revenue, and retail sales are weakening. In May, the pace of the 3-month moving average of retail sales slowed to 0.27% (from a peak of 1.09% in October 2010), while that of real retail sales fell 0.11% over the month (raw data here). Lower gas prices will help; but without significant relief in the labor market (from the private sector), the pace of revenue growth is unlikely to be maintained.

It’s not just the states – the health of state and local government’s (or lack of) matters A Lot for the US economy.

On average, state and local governments jointly are the largest single contributor to aggregate compensation in the 1990′s and 2000′s (roughly), according to the Bureau of Economic Analysis.

Since 1987, State and Local governments have accounted for an average 13% of total compensation of the US economy. So the outlook for 13% of aggregate compensation essentially depends on jobs growth in these sectors.

The trend for job growth has been decidedly negative for state and local governments. State and local governments have net-fired workers every single month since November 2010.

State and local governments are doing something they’ve not or rarely done before: hinder nonfarm payroll growth. In May 2011 (the latest data point), state and local governments dragged annual total payroll growth by 2% and 20%, respectively. Local government payroll was 11% of the total in May. This is not good.

Federal government support to state and local governments is set to decline significantly next year (see figure 2 on html of CPBB report). So it’s up to the private sector to provide sufficient income growth to offset the likely decline (latest data is 2009) by the giant of aggregate compensation, state and local governments, for years to come. I’m skeptical.

Rebecca Wilder

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Consumption and compensation: explicit and implicit wealth effects in finance

Readers of this blog know that I am in finance, specifically global fixed income. This blog post covers wealth effects in the financial industry, which is a relatively dominant share of total US compensation, 7.3% in 2009 and likely higher now (data are truncated at 2009). My view is that economists underestimate the wealth effects on consumption in the financial industry, given that financial wealth affects not only portfolio net worth but also the present value of labor income. Therefore, the sell-off in global risk assets may hit consumption more than expected in coming quarters, given that finance is the fifth largest industry, as measured by total compensation, on average spanning the years 1989-2009.

Why US consumption matters. The outlook for the US economy is of utmost importance to that for the world, given that the US will hold an average 22.1% of World GDP through 2016 (measured in $US), according to the IMF April 2011 World Economic Outlook. And the outlook for the US consumer is of utmost importance to that of the US economy, given that personal consumption expenditures hold a large 71% share of 2010 US GDP. Therefore, holding the US consumer share constant, US consumption is expected to be 15% of the global economy on average through 2016.

How wealth usually matters for US consumption. In economics, one of the drivers of consumption patterns ‘now’ is the wealth effect, usually defined as the shift in consumption due to changes in tangible (home values) and intangible (paper assets, like stocks and bonds) net assets.

(click to enlarge)

(Read more after the jump!)
The chart above illustrates the ‘wealth effect’ on consumption as the ratio of net worth to disposable income (blue dotted line) as it’s correlated to the consumption share (outlays really, see table 1 for the breakdown) of disposable income (green line). The consumption (outlay) share is is 100 less the saving rate.

A large part of the Fed’s quantitative easing program (QE) was targeted at stimulating the positive wealth effects on consumption via higher risk asset prices. I would argue that this has been largely successful to date. The two year moving average of the consumption share (green solid line) fell precipitously following the financial crisis, only to generally stabilize since Q1 2009; this is largely coincident with the outset of QE1.

Back to why I brought up finance. There’s another effect in play here, more specifically related to the compensation structure in the financial industry. See, along with the tangible and intangible net asset values, total wealth includes the present value of labor income, i.e., the present value of lifetime compensation.

For all industries except finance, lifetime income is generally not associated with financial markets and risk assets, except via interest payments on fixed income. However, in finance total compensation is directly impacted by asset values via the bonus structure, often a large part of total compensation. Therefore, when asset markets are challenged, this likely affects the present-value of labor income adversely.

There’s an outsized wealth effect of net asset values in the financial industry: the direct wealth channel (net asset worth) plus the indirect channel (present value of labor income) on consumption.

Why is the financial industry important? It’s pretty simple: financial compensation is a large part of total US compensation, 7.3% in 2009, which has grown an average of 6% annually since 1988 in nominal terms. (Note: you can get this data from the BEA’s industry tables).

As financial markets take a turn for the worse – the S&P grew 5.4% December 31, 2010 through March 31, 2011 and is now down 4.1% since March 31, 2011 – the adverse wealth effect is likely to be stronger in the financial industry than in any other industry. For north of 7% of total US compensation, labor income is challenged in expectation, which is likely to drag consumption.

Purely anecdotal evidence. This strong wealth effect exists in my household. Both my husband (equities) and I (fixed income) are in finance; and when markets are challenged, we tend to save more. And it’s not because our stock portfolio is showing holes – actually, we don’t have much of a stock portfolio – it’s because our household income falls in expectation via the ‘bonus’ component of financial salaries.

I haven’t seen any work done on this wealth effect channel – but it does beg the question of whether there will be further downgrades to the US economic forecast if risk assets continue to sell off.

Rebecca Wilder

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Who cares about the unemployed…

…it seems that way, at least, when I listen to much of the rhetoric coming out of Washington.

But it’s not just Washington, it’s Wall Street, too. In my line of work, finance, market participants grapple with the monthly economic data flow, eyeing each release as if it’s telling a new story about the current prospect for US economic growth – that it isn’t just treading water. ‘Consensus’ economists forecast their expectations for the economic release of the day, the market then trades based on the surprise to which the data beat or disappointed expectations. Day in, day out, that’s what we do.

I have a problem with this automated way of viewing the world. It’s tough to hear Wall Street economists defend their forecasts, stating that ‘oil’ or ‘Europe’ are the primary risks to the outlook; or that the structural unemployment rate has risen markedly so that harmful inflation is right around the corner. Step back, take a look at where 2.7% annual growth (current Consensus for 2011) actually gets the US labor market (see chart below).

The biggest risk to the outlook is not oil, it’s unemployment. The longer that the labor market remains idle – in fact, the labor force is now trending downward – the lower will the average skill level will go. Then you’re going to get something much more structural, the so-called positive feedback loop.


People move to the US for the American Dream – I wonder where they’ll go now…. Germany?

The chart above illustrates the harmonized G7 unemployment rates indexed to 2007 for comparability. The latest readings (June mostly) are listed in the legend.

The US labor market, as measured by the unemployment rate, deteriorated much more precipitously than that in any other G7 country. Germany stands out as the sole labor market that’s shown any marked improvement, furthering a trend that started with the the Hartz Concept. (I just did a Google search of the Hartz commission and came across this Economist article written in 2002 – remarkable.)

Policy drives the structural level of unemployment, not the other way around. In the US, there are currently no true boundaries to the supply of labor, rather it’s demand. Congress should be targeting job creation and aggregate demand, not the 2012 elections.

Stephen Gandel is right: there is no upside to high unemployment, just downside. You want to drop the deficit? Create jobs and aggregate demand so that the population ‘can’ pay taxes.

Rebecca Wilder

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Here’s to hoping: wage, salary, and income gains

There are reasons to expect the second half of the year to be be stronger than the first. Here are two: (1) the rebound in industrial activity following supply chain disruptions, and (2) possible impetus to investment spending coming from the depreciation allowance that expires this year. These factors, though, are just dressing up what may be weak underlying demand. Why? Because without significant jobs growth, it’s unclear that we’ll see the wage, salary, and income generation needed for a healthy continuation of the deleveraging cycle.

On the bright side, the Q1 2011 Gross Domestic Income, GDI, report does show a smart rebound in wage and salary accruals. The problem is, that corporate profit growth, which generally leads wage and salary accruals growth, is slowing. (GDI is the income side of the BEA’s GDP release and you can download the data here.)

The chart illustrates annual domestic profit and wage/salary growth spanning 1981 Q1 to 2011 Q1. The series are deflated by the GDP price index. Real domestic profit growth has been robust, peaking at 65% Yr/Yr in Q4 2009 and decelerating to 7% in Q1 2011. The surge in corporate profits brought real wage and salary accruals growth to a 2.1% annual pace in Q1 2011.

With higher input costs and slowing productivity gains, domestic profit margins are likely to be squeezed unless demand re-emerges smartly. The implication is that real wage and salary accruals growth may be nearing ‘as good as it gets’ territory during the aftermath of a balance sheet recession.

And labor’s losing it’s share of the pie. The chart below illustrates the various component contributions to annual gross domestic income growth. (the best that I could do on size vs. clarity – click to enlarge)

The data are quarterly data spanning 1981 Q1 to 2011 Q1 and deflated by the GDP price index. Wage and salary accruals have become a smaller part of income growth in the last decade. Spanning 1981-2000, the average contribution to income growth from wage and salary accruals was 1.5% (simple average), where that spanning the years 2001-current was just 0.3%. The average corporate profit contribution held firm over the same two periods, roughly 0.3%.

Growth momentum has slowed over the period, however, the deceleration in wage and salary contribution is quite striking. I can’t explain it even with the ‘demographic shift’; but this trend is likewise reflected in the employment to population ratio.

Wages, income, spending power, consumption, saving – they’re all different ways to say the same thing: earned income can be spent in one of three ways, on taxes, consumption, or saving. And in this recovery, saving via income gains is important as households further deleverage. We can’t afford compensationless expansion.

The key to growth in 2011 and 2012 is wages, salaries, and income – here’s to hoping.

Rebecca Wilder

Update: Spencer has a foreboding point in comments from my earlier post on GDP. He notes that inflation measured by the GDP deflator probably understates the impetus to domestic prices – domestic purchases is more appropriate at a 3.8% annual rate. The implication, according to Spencer via Email is, “If the inflation rate is really 3.8%, not 1.9 %, it strongly implies that the dominant cause of the economic weakness is higher inflation, not supply chain disruptions.”

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GDP – a disappointing report

Yesterday I addressed the weak high-frequency indicators, specifically with respect to leading indicators of investment spending on equipment and software (durable goods). I argued that Q2 has not started off well, given that the real core orders for capital goods are down compared to the January to March average.

The BEA reported that Q1 2011 growth was 1.8% on a seasonally-adjusted and annualized basis, which is unrevised from the first release but the composition of spending changed somewhat. On the margin, Q1 2011 looks a bit less stellar (if you can call 1.8% annualized growth ‘stellar’) with consumption growth being revised downward to 2.2% over the quarter (previously 2.7%). Below is an illustration of the Q1 2011 contributions to GDP growth before 8:30am (1.75%) and after 8:30am (1.84%).

I think that the story is pretty simple: higher gasoline prices is even worse for consumption than initially anticipated, and inventory accumulation remains a large driver of economic performance.

It’s still way to early to predict what the entirety of 2011 will bring – the IMF forecasts 2.8% annual growth – but the bar’s rising on the quarterly growth trajectory to attain that level of growth. I suspect that forecasts will be revised downward.

Although this is purely conjecture since the April figures are only recently rolling out, Q2 2011 growth is unlikely to be much better. Investment spending is already looking weak for April. And consumption growth may be lackluster on auto sales (H/T spencer) – durables consumption accounted for half of the quarterly growth rate in consumption (0.66% contribution to total GDP quarterly growth). Government spending is a drag, so it’s up to net exports!

Let’s look at what’s happened to the spending components of GDP during the ‘recovery’.

The chart illustrates the cumulative growth in the spending components of GDP (ex inventories). Exports and imports have bounced back on a strong rebound in international trade, 21% and 20%, respectively. Domestic spending is being driven largely by investment spending: consumption is 4% above it’s lows, while fixed investment spending is up 8% (of course, the decline was much larger). Government spending is broadly unchanged (-0.2%) since the outset of the recovery.

There’s much more to this report, like profits and wages, so I’ll revisit if time permits.

Rebecca Wilder

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Durable goods orders: more evidence of near-term weakness in the US economy

They keep calling it a ‘soft patch’ in my business; but when’s the data going to show otherwise? This soft patch is persistent, and durable goods orders confirm it into Q2 2011.

Note: The ‘all manufacturing’ orders Y/Y growth rate are available through March only in Datastream for the chart above; the nondefense capital goods ex aircraft orders are current through Aptil.
READ MORE AFTER THE JUMP!From the Census April preliminary release on durable goods orders and shipments:

New orders for manufactured durable goods in April decreased $7.1 billion or 3.6 percent to $189.9 billion, the U.S. Census Bureau announced today. This decrease, down two of the last three months, followed a 4.4 percent March increase. Excluding transportation, new orders decreased 1.5 percent. Excluding defense, new orders decreased 3.6 percent.

We know that the auto industrial production print was influenced by the supply chain disruptions stemming from the Japanese earthquake. This probably affected the durable goods orders and shipments as well. Furthermore, the big monthly drop was driven (partially) by a large 30% decline in nondefense aircraft and parts orders over the month.

But the gist of the report, in my view, was disappointing. Total durable goods shipments fell 1% over the month, while new orders plummeted 3.6%. This is a very volatile series, and the March growth in new orders was revised upward to 4.4% over the month from 2.5%; but the average growth rate in ‘core orders’ is showing holes.

Core durable goods orders, ‘nondefense capital goods excluding aircraft’ – a leading indicator of domestic investment spending on equipment and software – fell 2.6% over the month. Volatile, yes; but the real core goods orders turned negative, -0.33% on a 3-month average growth basis, furthering a downward trend that’s been in place since January 2011. The April figure was down 0.2% on a real basis compared to the January-March 2011 average – not a good start to Q2 2011.(The real series is constructed using the CPI durable goods deflator.)

The contributions to Q1 2011 fixed investment spending demonstrate that the entirety of fixed investment growth came from equipment and software, 0.8% quarterly contribution. (On data, you can view the contributions data in Table 2 of the release here or download the data for the entire report here.)

So when will this ‘soft patch’ end? Neil Soss today tells me that 2H 2011 will be quite the kicker, as the temporary supply chain disruptions to industrial activity wear off. We’ll see. It’s going to take quite a bit of growth in 2H 2011 to get the US back on track to the consensus 2011 growth forecast of 2.7% (according to Consensus Economics May report).

Rebecca Wilder

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"Survey says"…. German growth has probably peaked

This week further evidence has emerged of Germany’s slowing growth trajectory. At 4.9% annual growth (calendar-adjusted) and a tightening bias from the ECB, this was, of course, to be expected.

Yesterday the Manufacturing May ‘Flash’ PMI by Markit Research highlighted, in my view, that sentiment is unlikely to remain at these absurdly elevated levels indefinitely, as the index dropped to 58.2 from 62 in April. Notably, the index remained above 60 for five consecutive months.

Today the Ifo Institute released its business survey for May, revealing that industry and trade remained stable in May. This index hovers at record highs compared to a post-unification time series.

Overall, while the two sentiment indicators diverged this month (the PMI waning, while the Ifo holding firm), the story remains that Germany is slowing down. Furthermore, the Ifo survey portends a deceleration in industrial production growth (IP), perhaps over the next quarter.

Exhibit 1 The ratio of the components of Ifo – expectations and current conditions – suggest a sharp reversal in the industrial production growth trend.

The chart correlates annual industrial production growth with the % differential between the expectations and current conditions components of the Ifo index at a 6-month lead. I don’t expect IP growth to turn negative, but a slowdown is certainly due.

Exhibit 2 Take the Ifo sentiment with a grain of salt!

Ifo really is more of a coincident indicator of economic growth than anything else. For example, the Ifo composite has a 77% correlation coefficient with annual real GDP growth. Previous to the current recovery/expansion, the Ifo index hit a peak of 108.7 in March 2008 only to see growth decelerate sharply the next quarter, 2.7% Y/Y to 1.6% Y/Y. My point is, while it’s a decent indicator of economic strength during expansions, it’s a terrible predictor of turning points.

We’re not at a turning point now – Ifo plus PMI demonstrate that the German economy continues to expand, albeit at a slower pace.

The real question is, what does this mean for the rest of Europe, specifically the Periphery? It’s not totally clear, but certainly with Germany contributing more than 50% to the quarterly growth rate in Q1, downside risks are emerging. Prieur du Plessis argues that this is related to the global slowdown in manufacturing.

Rebecca Wilder

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Greece is in a pickle

There is growing discord between the ECB and national politicians over a ‘soft restructuring’ of Greek debt. The ECB doesn’t want it, while national policy makers grapple over it.

And just in case you were wondering what a soft restructuring actually is, Joseph Cotterill at FT Alphaville explains.

Beyond the gobbledygook restructuring talk is a simple story of incentives and the outlook for the Greek economy in the face of default. Over at Roubini Global Economics, Edward Hugh investigates the issue:

Put another way, if the most valid argument against going back to the Drachma always was that this would imply default, now that default is coming, why not allow Greece to devalue?

The problem is that Greece’s manufacturing sector is NOT competitive, nor will it be under even the most severe fiscal austerity measures…not to mention that the fiscal austerity measures make their problems worse by deepening the domestic recession. Barring permanent fiscal transfers, they need a currency devaluation in order to gain any sort of competitiveness back.

According to the Surveillance of Intra-Euro-Area Competitiveness and Imbalances (.pdf here), Greece faces the following:

In view of Greece’s weakened competitiveness in the euro area and its persistent current account deficit, adjustment in the context of the euro area would be facilitated by relative price and cost adjustments and a shift of resources from the nontradable to the tradable sector.

This is difficult to do without devaluation. An it’s not going to improve with a lower stock of debt (through restructuring)!

According to Eurostat, the 4-quarter MA (Angry Bear blog calculations) of Greece’s export base as a share of GDP has improved by just 0.6% of GDP from its low, while Ireland’s export base as a share of GDP has improved a large 22% of GDP.

Greece is getting most of the impetus to net exports via a sharp drop in import demand. A squeeze in import demand can technically grow GDP, but only so far.

Again – how’s the economy to grow after default? Greece needs a devaluation to shift resources from the nontradable to the tradable sector. (from the EU report)

Rebecca Wilder

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Euro area inflation: gaining momentum below the hood

Today Eurostat released April 2011 inflation for the Euro area. Prices are increasing at a 2.8% annual pace, up from 2.7% in March and very much above the ECB’s comfort zone of around but slightly below 2%.

Today’s report is the second release and includes the cross section of price gains below the headline number. The first ‘flash’ estimate does not specify the breakdown.

Inflation’s hitting all sectors, goods (primarily) and services alike, via inputs to production.

READ MORE AFTER THE JUMP!April core prices rose 1.6% over the year. The goods-price inflation is flowing into the the service-sector as well – headline service-sector inflation is 2.0% in April, up from its low of 1.2% one year ago. There may be some seasonal distortions here associated with the Easter holiday, but the upward momentum has been established.

Price gains at the country level are broad based.

2% annual inflation is increasingly ubiquitous for key countries, Periphery and Core core alike. Below is the diffusion of 2% annual price gains, where an index value above 50 indicates that the majority of component prices are rising at a 2% rate. The legend indicates the longer-term average diffusion of price gains.

Germany is still seeing the majority of annual price gains below 2% – the current index is 43 – but the breadth of 2% inflation is increasing beyond its longer-term average of 34.8. In Spain and Italy, current inflation diffusion indices are likewise increasing, where Spanish price gains are broad, 55.6 in April.

And it’s not just VAT taxes.

The chart below illustrates the tax-adjusted inflation rate across the Eurozone (ex Ireland, unfortunately, whose data is unavailable, Austria, Estonia and Cyprus). This series is lagged one month.

The tax-adjusted inflation rate assumes that all tax hikes are passed fully through to final goods prices. It gives a proxy for the inflation effect of fiscal austerity (hike in VAT, for example).

Although the uptick in inflation is warranted at this stage in the recovery, especially in the core, the momentum in prices can no longer be attributed to taxes only – it’s broader than that. Greece, for example, saw its inflation rate peak around 5.6% in September 2010 when its tax-adjusted inflation rate (inflation excluding VAT) was just 1.1%. Now, however, the headline and tax-adjusted inflation rates are converging, 4.5% vs 1.7% in March. Much of the tax-adjusted inflation can be attributed to food and energy; nevertheless, the base effects of the VAT hikes are wearing off.

Tricky times for Euro area policy makers when the Core AND the Periphery are showing such broad price gains. Meanwhile, the Periphery are contributing little by way of growth.

Rebecca Wilder

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