## WAGE AND INFLATION DYNAMICS IN DENMARK

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### A. Introduction
- Nominal wage growth in Denmark remained around 3½ percent (year-over-year) in 2022:Q4, well below headline inflation, placing real wage growth in negative territory.
- Headline inflation peaked at 11½ percent (year-over-year) in October 2022 and has eased since but remains elevated.
- Labor markets remain relatively tight with the unemployment rate in the lowest range since the late 2000s.
- Recent collective agreements called for wage growth of about 5 percent annually over the next two years.

### B. Inflation Dynamics: A Deeper Dive
- Headline inflation drivers:
  - Mainly driven by energy prices; moderating energy prices should mechanically reduce headline inflation.
- Core inflation decomposition:
  - Components sensitive to post-pandemic reopening (pent-up demand) and to supply chain disruptions were analyzed following Gonçalves and Koeste (2022).
  - Pent-up demand had a more sizable contribution to core inflation in Denmark than supply chain disruptions, with a relative split broadly similar to the euro area.
  - Rent for housing and remaining others make up the rest of core inflation.
- GDP deflator decomposition (national accounts identity):
  - GDP deflator = unit labor cost (employee compensation) + unit profit (gross operating surplus and mixed income) + taxes.
  - In 2022, unit labor cost contribution was relatively small, consistent with modest wage growth.
  - Unit profit had a sizable contribution in Denmark relative to unit labor cost and relative to unit profit in the euro area.
  - Aggregate unit profit was driven by the energy sector (mining and utilities) and significantly by the trade, travel, accommodation, and food sector.
- Historical evidence:
  - Experience from the euro area during oil price shocks suggests unit labor cost, while muted initially, is likely to increase subsequently.
  - Given realized high inflation and tight labor markets, wage contributions to price deflators are likely to pick up.

### C. Empirical Approach
- Two complementary models deployed:
  - Wage Phillips curve model to investigate how nominal wage dynamics depend on headline inflation, slack, and other determinants.
  - Interacted panel vector autoregressive (IPVAR) model to assess how wage pressures are passed on to core inflation and how passthrough depends on inflation expectations and corporate profitability.
- Wage Phillips curve baseline regression (notation preserved from source):
  - wt = β0 + β1 wt−1 + β2 ugap t−1 + β3 πt−4 + β4 upopp t + β5 eexpect t−4 + εt
- Variables and estimation details:
  - w denotes nominal wage growth.
  - Unemployment gap (ugap) based on a trend unemployment rate estimated using the Hodrick-Prescott (HP) filter.
  - Headline inflation (π), lagged, used as a proxy for adaptive inflation expectations.
  - Error-correction term (ecm) based on estimated long-term relationship between level of real wages and productivity.
  - Controls include contemporaneous productivity growth (prod) and lagged nominal wage growth.
  - Model estimated using quarterly data for Denmark during 2000–22.

### D. Wage Phillips Curve: Key Findings
- Estimated coefficients and dynamics:
  - The slope on the unemployment gap is negative (statistically significant).
  - Lagged headline inflation correlates positively with nominal wage growth, indicating partly backward-looking wage formation.
  - The error-correction term coefficient is negative and statistically significant: deviations of real wages from long-run relationship with productivity correct over the short term.
  - All estimated coefficients in baseline specifications are statistically significant.
  - Rolling (16-year) regressions suggest a rising importance of slack and lagged inflation for wage dynamics in recent periods.
- Quantitative contributions in 2022:
  - Lagged inflation explained as much as half of nominal wage growth during 2022.
  - Tightness in the labor market (negative unemployment gap) contributed to wage increases.
  - Real wage deviated negatively from the estimated long-run relationship (implying future upward pressure via the error-correction term, which enters with a lag).
  - Productivity growth mostly exerted a downward wage pressure in 2022.
- Near-term outlook for wages:
  - Given realized high inflation and still-tight labor markets, wage pressures are expected to remain elevated in the near term.
  - Backward-looking wage formation implies realized headline inflation will assert wage pressures in the near term.
  - Labor market indicators (survey of employment expectations, job vacancy rate, labor shortages) point to pick-up in labor demand.
  - Outcome of recent collective bargaining (about 5 percent growth annually during 2023–24) is broadly consistent with the wage Phillips curve implication.

### E. Wage Passthrough to Core Inflation
- Passthrough determinants:
  - Anchoring of inflation expectations.
  - Corporate profitability.
- IPVAR model setup:
  - For country i and period t, the vector includes import price inflation (πm), nominal wage growth adjusted for trend productivity (w), core consumer price inflation (π), and unemployment gap (u).
  - The IPVAR is a panel VAR with coefficients evolving deterministically according to a chosen conditioning factor (anchoring of inflation expectations or corporate profitability).
  - Model estimated for a panel of 27 European countries using quarterly data up to 2019:Q1.
  - Anchoring measure: deviation of Consensus inflation forecasts from the inflation target (less deviation implies better anchoring).
  - Corporate profitability: gross operating surplus and mixed income of nonfinancial corporations as a share of their GVA.
- Passthrough results:
  - Immediate impact of a wage shock on core inflation is relatively small but increases over time.
  - Passthrough ratio (cumulative response of core inflation due to a wage shock divided by cumulative response of wage to its own shock) is much larger at the end of the third year than at the end of the first year.
  - When inflation expectations are better anchored: less than 20 percent of wage growth would be passed on to core inflation at the end of the third year.
  - When inflation expectations are poorly anchored: passthrough can reach close to 50 percent at the end of the third year.
  - When corporate profitability is higher: wage passthrough is smaller.
  - Indicative wage passthrough ratio for Denmark, based on latest available anchoring and corporate profitability, is in the range of 25–30 percent (at the end of the third year).

### F. Policy-Relevant Implications
- Reasons for determined policy to fight inflation:
  - Backward-looking wage formation that transmits realized headline inflation into wage pressures.
  - Tight labor markets and recent collective bargaining outcomes that support elevated near-term wage growth.
  - Nontrivial wage passthrough to core inflation—conditional on anchoring of expectations and corporate profitability—implying some of the wage pressures will sustain core inflation.
- Key channels to limit wage-driven inflation persistence:
  - Strengthen the anchoring of inflation expectations to reduce passthrough (better-anchored expectations associated with lower passthrough: <20 percent by year 3).
  - Monitor corporate profitability dynamics, as higher profitability can absorb wage costs and reduce passthrough.
  - Recognize the role of unit profits (not only wages) in recent inflation dynamics and factor this into policy assessments.
- Fiscal policy guidance:
  - Near-term fiscal policy should therefore support disinflation.

### Near-term inflation expectations remain
- Inflation expectations:
  - Expectations for Denmark over the next 12 months (derived from Consensus Forecasts) remain elevated at around 4½ percent.
  - These near-term expectations have edged down most recently; the direction is also consistent with surveys of consumer expectations of inflation.
  - Medium-term inflation expectations in the euro area: 5-year expectations from the Survey of Professional Forecasters are around 2¼ percent, which is close to the 2 percent target.
  - Implication: high inflation would persist in the near term, even though expectations remain anchored for now.
- Corporate profitability and passthrough:
  - Aggregate corporate profitability in Denmark remains high relative to the euro area.
  - The increase in corporate profitability during 2022 was driven by the energy and transport sectors.
  - Danmarks Nationalbank analysis suggests that without these sectors, aggregate profitability in 2022 (around 46 percent) would be below the pre-pandemic level; nonetheless, it would still be higher than that in the euro area (around 42 percent).
  - Implications:
    - Broadly robust corporate profitability should help firms absorb some expected wage pressures, attenuating passthrough to inflation.
    - At the firm level, variation exists: firms with thin profit margins could experience higher passthrough from wages to prices.
    - Wage discipline in firms with thin margins is important for keeping a lid on inflation.
- Wage dynamics and inflation persistence:
  - Historical evidence indicates wage formation in Denmark has been partly backward looking despite the absence of formal indexation to inflation.
  - Labor market tightness (slack) has played a role; thus, the wage Phillips curve is active.
  - Given the historical wage dynamics, high headline inflation realized so far, and still-tight labor markets:
    - Wage pressures are expected to remain high in the near term, sustaining high inflation.
    - Some wage pressures are expected to be passed on to core inflation, contributing to persistence.
    - The passthrough would be larger if inflation expectations become deanchored.

### Technical notes (selected)
- Decomposition of HICP core inflation follows Gonçalves and Koeste (2022), categorizing 2-digit HICP components into: (i) sensitive to supply chain disruptions; (ii) sensitive to re-opening; (iii) rent; and (iv) remaining. Components are aggregated using HICP weights.
- Long-run regression: the log-level of real wage is regressed on the log-level of real productivity. Real wage is derived by deflating nominal wage with headline HICP and indexing to long-term average (2000–22 = 100). Estimated coefficient for real productivity is close to unity and statistically significant.
- Wage Phillips curve database and robustness:
  - Nominal wage: gross wages and salary per hour. Productivity: gross value added per hour. Headline inflation: HICP index. Variables transformed as year-on-year growth rates.
  - Unemployment gap: deviation from trend unemployment estimated via HP filter.
  - Inflation expectations in the next 12 months derived from Consensus Forecasts using a weighted average of current and one-year ahead forecasts (following Buono and Formai (2018)).
  - Robustness checks: including lagged inflation and forward-looking expectations; near-term inflation expectations often correlate with lagged inflation causing identification issues. Inflation expectations for Denmark, Germany, and the euro area (near and medium terms) were considered but often statistically insignificant. Including German wages produces a positive and statistically significant coefficient, indicating German wage dynamics matter for Danish wages.
- Long-run wage regression results (summary):
  - Coefficient on Productivity level (log): 1.173*** (0.043)
  - Constant: -0.799*** (0.197)
  - Observations: 92
  - R-squared: 0.893
  - Note: Standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1.

*Source: IMF staff analysis from "Wage and Inflation Dynamics in Denmark" (June 1, 2023).*

### References _____________________________________________________________________________ 13

### WAGE AND INFLATION DYNAMICS IN DENMARK

### A. Introduction
- Nominal wage growth in Denmark remained around 3½ percent (year-over-year) in 2022:Q4, well below headline inflation, placing real wage growth in negative territory.
- Headline inflation peaked at 11½ percent (year-over-year) in October 2022 and has eased since but remains elevated.
- Labor markets remain relatively tight with the unemployment rate in the lowest range since the late 2000s.
- Recent collective agreements called for wage growth of about 5 percent annually over the next two years.

### B. Inflation Dynamics: A Deeper Dive
- Headline inflation has been driven mainly by energy prices; moderating energy prices should mechanically reduce headline inflation.
- Core inflation decomposition:
  - Components sensitive to post-pandemic reopening (pent-up demand) and to supply chain disruptions were analyzed following Gonçalves and Koeste (2022).
  - Pent-up demand had a more sizable contribution to core inflation in Denmark than supply chain disruptions, with a relative split broadly similar to the euro area.
  - Rent for housing and remaining others make up the rest of core inflation.
- GDP deflator decomposition (national accounts identity):
  - GDP deflator = unit labor cost (employee compensation) + unit profit (gross operating surplus and mixed income) + taxes.
  - In 2022, unit labor cost contribution was relatively small, consistent with modest wage growth.
  - Unit profit had a sizable contribution in Denmark relative to unit labor cost and relative to unit profit in the euro area.
  - Aggregate unit profit was driven by the energy sector (mining and utilities) and significantly by the trade, travel, accommodation, and food sector.
- Historical evidence:
  - Experience from the euro area during oil price shocks suggests unit labor cost, while muted initially, is likely to increase subsequently.
  - Given realized high inflation and tight labor markets, wage contributions to price deflators are likely to pick up.

### C. Empirical Approach
- Two complementary models deployed:
  - Wage Phillips curve model to investigate how nominal wage dynamics depend on headline inflation, slack, and other determinants.
  - Interacted panel vector autoregressive (IPVAR) model to assess how wage pressures are passed on to core inflation and how passthrough depends on inflation expectations and corporate profitability.
- Wage Phillips curve baseline regression (notation preserved from source):
  - wt = β0 + β1 wt−1 + β2 ugap t−1 + β3 πt−4 + β4 upopp t + β5 eexpect t−4 + εt
  - Variables and estimation details:
    - w denotes nominal wage growth.
    - Unemployment gap (ugap) based on a trend unemployment rate estimated using the Hodrick-Prescott (HP) filter.
    - Headline inflation (π), lagged, used as a proxy for adaptive inflation expectations.
    - Error-correction term (ecm) based on estimated long-term relationship between level of real wages and productivity.
    - Controls include contemporaneous productivity growth (prod) and lagged nominal wage growth.
    - Model estimated using quarterly data for Denmark during 2000–22.

### D. Wage Phillips Curve: Key Findings
- Estimated coefficients and dynamics:
  - The slope on the unemployment gap is negative (statistically significant).
  - Lagged headline inflation correlates positively with nominal wage growth, indicating partly backward-looking wage formation.
  - The error-correction term coefficient is negative and statistically significant: deviations of real wages from long-run relationship with productivity correct over the short term.
  - All estimated coefficients in baseline specifications are statistically significant.
  - Rolling (16-year) regressions suggest a rising importance of slack and lagged inflation for wage dynamics in recent periods.
- Quantitative contributions in 2022:
  - Lagged inflation explained as much as half of nominal wage growth during 2022.
  - Tightness in the labor market (negative unemployment gap) contributed to wage increases.
  - Real wage deviated negatively from the estimated long-run relationship (implying future upward pressure via the error-correction term, which enters with a lag).
  - Productivity growth mostly exerted a downward wage pressure in 2022.
- Near-term outlook for wages:
  - Given realized high inflation and still-tight labor markets, wage pressures are expected to remain elevated in the near term.
  - Backward-looking wage formation implies realized headline inflation will assert wage pressures in the near term.
  - Labor market indicators (survey of employment expectations, job vacancy rate, labor shortages) point to pick-up in labor demand.
  - Outcome of recent collective bargaining (about 5 percent growth annually during 2023–24) is broadly consistent with the wage Phillips curve implication.

### E. Wage Passthrough to Core Inflation
- The degree of wage passthrough to core inflation depends on:
  - How anchored inflation expectations are.
  - How profitable corporates are.
- The IPVAR model setup:
  - For country i and period t, the vector includes import price inflation (πm), nominal wage growth adjusted for trend productivity (w), core consumer price inflation (π), and unemployment gap (u).
  - The IPVAR is a panel VAR with coefficients evolving deterministically according to a chosen conditioning factor (anchoring of inflation expectations or corporate profitability).
  - Model estimated for a panel of 27 European countries using quarterly data up to 2019:Q1.
  - Anchoring of inflation expectations measure: deviation of Consensus inflation forecasts from the inflation target (less deviation implies better anchoring).
  - Corporate profitability: gross operating surplus and mixed income of nonfinancial corporations as a share of their GVA.
- Passthrough results:
  - Immediate impact of a wage shock on core inflation is relatively small but increases over time.
  - Passthrough ratio (cumulative response of core inflation due to a wage shock divided by cumulative response of wage to its own shock) is much larger at the end of the third year than at the end of the first year.
  - When inflation expectations are better anchored: less than 20 percent of wage growth would be passed on to core inflation at the end of the third year.
  - When inflation expectations are poorly anchored: passthrough can reach close to 50 percent at the end of the third year.
  - When corporate profitability is higher: wage passthrough is smaller.
  - Indicative wage passthrough ratio for Denmark, based on latest available anchoring and corporate profitability, is in the range of 25–30 percent (at the end of the third year).

### F. Policy-Relevant Implications (from analysis)
- Determined policies to fight inflation are important given:
  - Backward-looking wage formation that transmits realized headline inflation into wage pressures.
  - Tight labor markets and recent collective bargaining outcomes that support elevated near-term wage growth.
  - Nontrivial wage passthrough to core inflation—conditional on anchoring of expectations and corporate profitability—implying some of the wage pressures will sustain core inflation.
- Key channels to limit wage-driven inflation persistence:
  - Strengthen the anchoring of inflation expectations to reduce passthrough (better-anchored expectations associated with lower passthrough: <20 percent by year 3).
  - Monitor corporate profitability dynamics, as higher profitability can absorb wage costs and reduce passthrough.
  - Recognize the role of unit profits (not only wages) in recent inflation dynamics and factor this into policy assessments.

*Source: IMF staff analysis from "Wage and Inflation Dynamics in Denmark" (June 1, 2023).*

### 16.      Near-term inflation expectations remain

### 16.      Near-term inflation expectations remain

### Inflation expectations: near term vs. medium term
- Inflation expectations for Denmark over the next 12 months (derived from Consensus Forecasts) remain elevated at around 4½ percent.
- These near-term expectations have edged down most recently; the direction is also consistent with surveys of consumer expectations of inflation.
- Medium-term inflation expectations in the euro area—key for gauging Denmark’s inflation outlook under its fixed exchange rate regime against the euro—remain well anchored:
  - 5-year expectations from the Survey of Professional Forecasters are around 2¼ percent, which is close to the 2 percent target.
- Implication: high inflation would persist in the near term, even though expectations remain anchored for now.

### Corporate profitability and passthrough to inflation
- Aggregate corporate profitability in Denmark remains high relative to the euro area.
- The increase in corporate profitability during 2022 was driven by the energy and transport sectors.
- Danmarks Nationalbank analysis suggests that without these sectors, aggregate profitability in 2022 (around 46 percent) would be below the pre-pandemic level; nonetheless, it would still be higher than that in the euro area (around 42 percent).
- Implications:
  - Broadly robust corporate profitability should help firms absorb some expected wage pressures, attenuating passthrough to inflation.
  - At the firm level, variation exists: firms with thin profit margins could experience higher passthrough from wages to prices.
  - Wage discipline in firms with thin margins is important for keeping a lid on inflation.

### Wage dynamics and inflation persistence
- Historical evidence indicates wage formation in Denmark has been partly backward looking despite the absence of formal indexation to inflation.
- Labor market tightness (slack) has played a role; thus, the wage Phillips curve is active.
- Given the historical wage dynamics, high headline inflation realized so far, and still-tight labor markets:
  - Wage pressures are expected to remain high in the near term, sustaining high inflation.
  - Some wage pressures are expected to be passed on to core inflation, contributing to persistence.
  - The passthrough would be larger if inflation expectations become deanchored.

### Policy conclusions and recommendations
- Determined policies to fight inflation are important; these policies will also have a direct impact on slack.
- Near-term fiscal policy should therefore support disinflation.

### Technical notes (selected)
- Decomposition of HICP core inflation follows Gonçalves and Koeste (2022), categorizing 2-digit HICP components into: (i) sensitive to supply chain disruptions; (ii) sensitive to re-opening; (iii) rent; and (iv) remaining. Components are aggregated using HICP weights.
- Long-run regression: the log-level of real wage is regressed on the log-level of real productivity. Real wage is derived by deflating nominal wage with headline HICP and indexing to long-term average (2000–22 = 100). Estimated coefficient for real productivity is close to unity and statistically significant.
- Wage Phillips curve database and robustness:
  - Nominal wage: gross wages and salary per hour. Productivity: gross value added per hour. Headline inflation: HICP index. Variables transformed as year-on-year growth rates.
  - Unemployment gap: deviation from trend unemployment estimated via HP filter.
  - Inflation expectations in the next 12 months derived from Consensus Forecasts using a weighted average of current and one-year ahead forecasts (following Buono and Formai (2018)).
  - Robustness checks: including lagged inflation and forward-looking expectations; near-term inflation expectations often correlate with lagged inflation causing identification issues. Inflation expectations for Denmark, Germany, and the euro area (near and medium terms) were considered but often statistically insignificant. Including German wages produces a positive and statistically significant coefficient, indicating German wage dynamics matter for Danish wages.
- Long-run wage regression results (summary):
  - Coefficient on Productivity level (log): 1.173*** (0.043)
  - Constant: -0.799*** (0.197)
  - Observations: 92
  - R-squared: 0.893
  - Note: Standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1.

*Source: IMF staff, "16. Near-term inflation expectations remain" (from sipea2023052).*

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_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2023/english/sipea2023052.pdf_