Understanding the Joint Dynamics of Inflation and Wage Growth in the Euro Area

Vahagn Galstyan

No 11/RT/23, Research Technical Papers from Central Bank of Ireland

Abstract: This paper presents an empirical framework and analysis of the interactions among inflation, wages, employment, and output in the euro area. Results identify price shocks and demand shocks as the primary exogenous factors explaining historical variance. The wage gap emerges as a key determinant of wage dynamics in the aftermath of a price shock. In contrast, the output gap becomes dominant following demand shocks. The real wage gap acts as a corrective mechanism, ensuring that prices and wages in particular align with the broader economic landscape. Forecasts for the period starting 2023Q3 emphasise the enduring significance of the real wage gap, projecting its ongoing impact on nominal wages in tight labour markets. As for inflation expectations, the estimates emphasise their stickiness. In this context, the significant and persistent price shock that has occurred suggests a gradual decline in expectations, potentially leading to an extended period of elevated inflation.

Keywords: Inflation; Wages; Central Banking. (search for similar items in EconPapers)
JEL-codes: E00 E12 E30 E31 E32 E37 (search for similar items in EconPapers)
Date: 2023-12
New Economics Papers: this item is included in nep-ban, nep-cba, nep-eec, nep-eur and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:cbi:wpaper:11/rt/23

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