Wage Growth and Inflation in Europe

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.

The Wage-Price Pass-Through in the Euro Area: Does the Growth Regime Matter?

“…This suggests that there may have been also more profound structural changes in the relationship over time or likewise a dependence of the relationship on certain states of the economy as has been suggested recently with regard to e.g. the inflation environment and Boranova et al (2019)).…”

“…In this regard, suggest that the inflation environment plays a role and that a lower inflation environment is associated with a lower pass-through. This is confirmed by Boranova et al (2019) who use an Interacted Panel VAR model to analyse the degree of the pass-through for different states of the economy and find that the pass-through is lower in periods of subdued inflation and inflation expectations, if the economy is subject to greater competitive pressures and when corporate profitability is robust.…”

“…The above results have shown that the wage-price relationship is highly complex, shock dependency creates non-linearities in the relationship and a number of studies hint at changes in the wage-price pass-through over time (see Peneva and Rudd (2017), Deutsche Bundesbank (2019), De Luigi et al (2019 and Boranova et al (2019)) and such changes are even evident when accounting for shock-dependence (Hahn (2019)). This could be an indication that the relationship may have also undergone broader structural changes over time which could for instance arise from changes in labour market institutions or the monetary policy setting.…”

“…De Luigi et al ( 2019) report a pass-through of unit labour cost shocks to inflation in most of the considered Central Eastern and South Eastern European countries but the impact is heterogeneous across countries and has weakened after the great recession. Finally, Boranova et al (2019) explore the transmission of unit labour cost shocks to inflation in 27 European countries, distinguishing between 16 advanced economies and 11 newer EU member states, over the period 1995 to 2019. Their results show that unit labour cost shocks are transmitted to inflation in both sets of countries, but the pass-through is higher for the newer EU member states, and consistent with the results of De Luigi et al ( 2019) the pass-through has declined in the period after the great recession.…”

A European Minimum Wage: Implications for Poverty and Macroeconomic Imbalances

“…On the other hand, as discussed in the first section, wage and price inflation in Europe have been diverging in recent years, which has translated into diverging price-vs. ULCbased REER movements. The pass-through is likely to be lower for surplus countries which tend to have a higher corporate profit share (Boranova et al, 2019, andIMF, 2019c). The coefficients used in the simulations to convert ULC-based REER changes into CPI-based REER changes are based on historical data and thus may overestimate the pass-through in the current environment.…”