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

Author

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  • Galstyan, Vahagn

    (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.

Suggested Citation

  • Galstyan, Vahagn, 2023. "Understanding the Joint Dynamics of Inflation and Wage Growth in the Euro Area," Research Technical Papers 11/RT/23, Central Bank of Ireland.
    • Handle: RePEc:cbi:wpaper:11/rt/23
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    References listed on IDEAS

    as
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Inflation; Wages; Central Banking.;
    All these keywords.

    JEL classification:

    • E00 - Macroeconomics and Monetary Economics - - General - - - General
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications

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