Why is Spanish inflation so low?

Good morning from New Economy Brief.

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Spanish inflation is now below 2% - the 3rd lowest in the Eurozone behind Belgium and Luxembourg - and it has been falling faster than in other Eurozone economies. Spain has also been implementing interesting policies to shield their citizens from the rising cost of living, and Spain’s President has claimed these have played a role in driving down inflation.

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This week’s New Economy Brief explores the Spanish government's use of ‘unconventional fiscal policies’, their role in reducing inflation, and the lessons that can be learnt for other governments. 

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How unconventional fiscal policies can help tackle inflation. There are growing calls for governments to use fiscal policies to tackle current high inflation levels, as opposed to relying on interest rate rises. The IMF’s Chief Economist, Pierre-Olivier Gourinchas has argued that ‘unconventional fiscal policies’ have played a significant role tackling inflation in the Eurozone by reducing inflation expectations and preventing inflation ‘passing through’ from areas hit with supply shocks into core inflation in the rest of the economy. 

• E.g. The energy price cap reduced UK inflation. Here in the UK, the energy price cap is an example of such an inflation-busting fiscal intervention, explained here by IPPR’s Carsten Jung 

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Spain’s policy interventions on the cost of living. The evidence does suggest that Spain has gone further than many European countries, and certainly further than the UK, in terms of intervening in its economy to hold down the prices of certain essentials and shield citizens from the rising cost of living. Let's have a look at some of these interventions.

• Insulating essentials from the rising cost of living. Economist Phillipp Heimberger has highlighted that the Spanish government was quick to implement price controls in the energy and rental market early on in response to this recent wave of high inflation. A peer-reviewed study by Jorge Uxó explores these interventions: “The authorities have adopted significant measures to reduce inflation, especially in energy (capping gas in the electricity market, limiting the gas price for consumers in the regulated tariff, lowering indirect taxes, or discounts for vulnerable households) and public transport and housing rents. Other measures include transfers to the most affected households and economic sectors to offset the effects of inflation.” (See page 24 for a table detailing each policy implemented until 2022.) 

• Making housing more affordable through rent controls. Since 2022 the Spanish government has prevented landlords increasing their rental prices by more than 2% higher than their previous contract as a measure to contain inflation. This has since been extended until 2024 and a new Housing Law has been introduced. Eduardo González de Molina, policy adviser at Barcelona City Council and affiliate academic at UCL IIPP, explains how the new housing law is informed by the idea of a ‘Right to Housing’ and the Catalan government’s experiments with rent controls. A new peer reviewed paper provides robust empirical evidence showing that the rent controls in Catalonia reduced average rents paid by between 4 and 6% without lowering the supply of housing. (UK Mayors have also been calling for powers to implement rent controls recently.)

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How have they impacted inflation? Spain’s President Pedro Sánchez claimed at the end of 2022 that the Spanish government’s use of various policy interventions had been successful in driving down Spain’s inflation rate to the lowest level in the Eurozone (nearly half the average, at the time), and protecting families from the cost of living crisis. 

• ‘Second-round’ effects may be lower. Reducing the ‘second-round effects’ of inflation passing from energy prices, and the other interventions undertaken to hold down prices will definitely have impacted the rate of inflation. Economist Jo Michell notes, “We have to be careful with causation, but the experience of other European countries suggests that unconventional tools are helping to bring down inflation”, also citing the Spanish case

• …but real wages have also taken a very big hit. However, Michell has warned about fully attributing Spain’s low inflation to these progressive policies. Other, more concerning particularities in the Spanish economy are also at play, most notably the fact that Spain suffered the worst erosion of real wages of any large economy in the Eurozone over 2022. This means Spanish workers lost more purchasing power as inflation swallowed any nominal wage increases. This major erosion of real wages could explain a lot of what’s behind Spain’s experience of lower inflation, and why the government is trying to use fiscal policy to offset the impacts of inflation on workers by protecting the cost of essentials. 

• Tackling profit-driven inflation? Spanish trade unions have agreed to lower than inflation level wage increases over a number of years but argued that any ‘social pact’ to tackle inflation should not just be borne by workers, but by companies' profit margins too. Firms are passing on higher costs to consumers via price rises, and protecting, or in some cases increasing, their profit margins. An annual report from the Spanish Economic and Social Council concluded that increases in Spanish corporate gross profits drove 90.7% of domestic inflation in 2022, with wages only contributing to 10.9% of the general price rises. Consequently, the Spanish government is launching a ‘Corporate Profits Observatory’ which will analyse corporate profits to aid collective bargaining processes and ensure a fairer distribution of surplus value between workers, shareholders and senior executives. This could help reduce future bouts of ‘greedflation’ spreading around the economy. 

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Lessons for the role of the state in an insecure world. While it remains unclear whether Spain’s unconventional fiscal policies have played a significant role in keeping down its inflation, the Spanish experience does illustrate the potential for the state to play a bigger role in protecting people's disposable incomes by ensuring they can afford the basic essentials. As climate change makes extreme weather events and supply-shocks much more common (e.g the El Niño weather event is expected to re-inflate global commodity prices another couple of percent), inflation is likely to become a more permanent feature of the global economy and a much bigger ongoing problem for government policy. ‘Unconventional fiscal policies’ can prevent second-round effects of inflation moving from supply shocks and becoming embedded into other sectors of the economy, and can redistribute its impacts more fairly. With elections only a week away, we will see whether Spain’s strategy to tackle inflation is also a solid political strategy.

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