By contrast, in Greece, Portugal and Spain reforms were less fast and comprehensive. In Spain, for instance, slow implementation of labour market reforms meant that wages continued to rise until the third quarter of 2011, despite output falling by almost 5% in that time. In Greece, labour market reforms were enacted early on but without in parallel opening up product markets, meaning that when wages adjusted, prices did not: the price level only began falling in October 2012. The result was that these countries experienced a quantity adjustment – higher unemployment – which triggered a protracted disinflationary process that is still ongoing.12 In sum, while both options have been costly in terms of output and employment, and notwithstanding differences in labour market flexibility, in a situation where countries had to undertake an internal devaluation, accelerating the pace of reforms seems to have been the better approach. It has led more quickly to higher growth prospects and higher current and expected inflation – i.e. conditions where the positive income effects of reforms can outweigh the negative real interest rate effects. This contrasting experience also, in my view, disproves the view that reforms should be staggered because political capital is scarce. We have seen that this type of thinking tends to lead to authorities avoiding taking on organised vested interests – such a protected sectors – and instead prioritising measures that affect a more diffuse group – such as lowering minimum wages.
They inevitably reduce real national income  Chart 16: Monetary policy cannot offset the fall in real incomes caused by a terms of trade shock  Page 27 Sources: ONS, Bank of England, Bloomberg Finance L.P. and Bank calculations. Nominal wages in the chart are private sector regular pay. It’s interesting too to ask what the world might now look like had this very steep path for interest rates been taken – but without any subsequent rise in import prices. The outcome of this experiment is the ‘alternative variant’ line in Chart 17. The predicted result – this despite the prior growth in household deposits – is a steep fall in inflation, well into negative territory. All this makes it a challenge, I think, to argue that the rise in broad money in 2020 is the main (or even an important) contributor to the inflation that’s followed. Chart 17: In the absence of big rises in import prices tighter policy would have pushed inflation into negative territory  Sources: ONS, Bank of England, Bloomberg Finance L.P. and Bank calculations. The ‘alternative variant’ reflects the same monetary tightening imparted in the ‘scenario’ but no increase in the contribution of import prices (energy and other goods) to CPI inflation relative to its pre-Covid average.