When Germany’s conservative central bank calls for wages to rise faster than in the past, you know that something has gone seriously wrong with Europe’s biggest economy.

What went wrong is that almost everyone in Frankfurt — home to the Bundesbank as well as the European Central Bank — underestimated how persistent low inflation would turn out to be. Eurozone inflation rates fell off a cliff in November, and stood at a mere 0.4pc in July. Russian sanctions will weigh on the European economy, keeping inflation rates low for longer. Italy is stagnating again, and elsewhere in the eurozone the economic recovery has lost momentum. Only Spain shows some growth — but with an unemployment rate of 24.5pc, I would not call this an economic recovery so much as a dead-cat bounce.

The German economy has been relatively strong by comparison. But even there inflation remains well below the ECB’s target of just under 2pc. Last year real wages in the economy fell by 0.2pc, according to a survey by the German Federal Statistical Office. The survey is not consistent with other official statistics because it captures effects not usually included in wage statistics, such as overtime payments. This year things have improved, but inflation is still not picking up.

The Bundesbank’s call for higher wages is a sign of desperation and a signal the German central bank is not willing to address the underlying problem: a fall in aggregate demand, brought on by a financial crisis, excessive austerity and repeated monetary policy mistakes. The eurozone does not need wage or price fixing

The Bundesbank is now calling for wages to rise by 3pc. Superficially, this reflects the logic of German wage negotiations, which begin by looking at two sets of data — national inflation rates and productivity growth. Wages go up by the rate of consumer price inflation plus some agreed percentage of the productivity increase. The idea is that workers’ real wages should never fall, and that workers and shareholders should both benefit from increases in productivity. The Bundesbank’s 3pc target reflects the ECB’s inflation target plus the entire loot of this year’s expected productivity growth.

There are three problems with this calculation. The first concerns inflation. Why should an employer pretend that prices will rise by 2pc when the ECB has repeatedly failed to meet that target? Inflation is 0.4pc now, and is not expected to hit the target during the one or two-year period of negotiated wage contracts.

The second problem concerns productivity increases, the fruits of which would be given to workers if the Bundesbank had its way. Workers would rejoice, but why should employers voluntarily give up all the productivity gains if they do not have to? The labour market reforms of the past decade have firmly tilted the playing field against the unions. Workers have a strong incentive to cling on to their jobs because unemployment would lead to a large loss of income. The whole point of the labour reforms has been to weaken the unions’ negotiating power, and to prevent wage increases out of line with productivity and inflation. Wage moderation is a feature of that system, not a bug.

The third problem is a growing disconnect between officially negotiated wage tariffs and actual wages. Only 18pc of the German workforce is unionised, one of the lowest levels in the EU. Plant-level agreements often counteract nationally negotiated deals. Some employers have reportedly been planning to circumvent the recently agreed statutory minimum wage, which comes into effect next year, by forcing workers into low-paid overtime.

For the conservative economists of the German mainstream, slippage in the inflation target is no big deal. They could happily live with zero inflation. So why does the Bundesbank feel compelled to call for more? Hans-Werner Sinn, president of the Ifo Institute for Economic Research, has said that the Bundesbank wants to pre-empt quantitative easing by the ECB.

It is a possible, if somewhat conspiratorial, interpretation. Whatever the reason, I doubt it will work. Twenty years ago the economic environment may have been more receptive. But the German labour market has changed. The country, once economically autonomous, is part of a monetary union almost four times its size.

The Bundesbank’s call for higher wages is a sign of desperation and a signal the German central bank is not willing to address the underlying problem: a fall in aggregate demand, brought on by a financial crisis, excessive austerity and repeated monetary policy mistakes.

The eurozone does not need wage or price fixing. It needs further monetary expansion. The ECB should have started large-scale asset purchases a year ago. It certainly should do so now. The EU should allow governments to overshoot their fiscal targets this year, and suspend the fiscal compact, which would result in further fiscal pain from 2016.

Eurozone policymakers have again landed themselves in a situation where they need to do the opposite of what they have been promising. Stagnation and falling inflation are the price the eurozone is paying for muddling through the crisis.

Published in Dawn, Economic & Business, Aug 11th, 2014