Money, Wages and Inflation in Middle-Income Developing Countries


.Money, Wages and Inflation in Middle-Income Developing Countries.
Pierre-Richard Agénor and Alexander W. Hoffmaister

This paper examines the short-run links between money growth, exchange rate
depreciation, nominal wage growth, cyclical movements in output, and inflation
in four middle-income developing countries: Chile, Korea, Mexico, and Turkey,
using generalized vector autoregression techniques. Variance decompositions
show that wage movements are greatly influenced by their own shocks at short
horizons, with inflation shocks playing a more important role at longer
horizons in all countries except Korea. They also indicate that, at short
forecast horizons, historical shocks associated with inflation largely explain
movements in inflation. Nominal exchange rate depreciation also plays a
substantial role in all countries except Korea. Shocks associated with wages
have little impact except in Mexico.

Impulse responses show that an innovation in the rate of growth of nominal
wages increases inflation in all effect that displays considerable
persistence over time in Mexico and Korea. Real wages also increase in all
countries. Output,

however, falls in some cases and rises in others, reflecting conflicting
demand- and supply-side effects, associated with the rise in wages. A fall in
the rate of depreciation of the exchange rate leads to a reduction in inflation
on impact in all countries. In Chile and Turkey, the shock is associated with a
transitory increase in output (despite a persistent increase in real wages),
whereas in Korea and Mexico output falls on impact. Finally, a temporary
increase in the rate of growth of the nominal money stock has an expansionary
effect on output, and only a short-lived impact on inflation in Chile, Korea,
and Turkey. In Mexico the effect on output is expansionary but short-lived,
whereas the effect on inflation is positive on impact and persistent. Nominal
wage growth increases significantly in Chile, Mexico, and Turkey, but not in
Korea. Real money balances in Korea, and to a lesser extent Mexico and Turkey,
increase initially but decline over time.