No abstract

Wages have been rising faster than productivity in many European countries for the past few years, yet signs of underlying consumer price pressures remain limited. To shed light on this puzzle, this paper examines the historical link between wage growth and inflation in Europe and factors that influence the strength of the passthrough from labor costs to prices. Historically, wage growth has led to higher inflation, but the impact has weakened since 2009. Empirical analysis suggests that the passthrough from wage growth to inflation is significantly lower in periods of subdued inflation and inflation expectations, greater competitive pressures, and robust corporate profitability. Thus the recent pickup in wage growth is likely to have a more muted impact on inflation than in the past.

In many European countries, prior to the pandemic, wages rose faster than productivity, yet consumer price pressures remained subdued. This is puzzling as theory suggests that inflation would pick up with a rise in wage growth that exceeds productivity growth. To shed light on this puzzle, we analyze the transmission of wage shocks to core inflation for a sample of 27 European countries over the period 1995Q1–2019Q1. More importantly, we assess how the transmission depends on a set of factors. We find that historically wage growth has led to higher inflation but the impact has weakened since the global financial crisis. Our analysis shows that the passthrough from wage growth to inflation is significantly lower in periods of subdued inflation and inflation expectations, greater competitive pressures, and robust corporate profitability.

for sharing their codes. We would like to thank Hyun Woo Park and Nomelie Veluz for excellent research and formatting assistance respectively. All remaining errors are our own.