## Interactions Between Public and Private Sector Wages and Inflation in Mongolia

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### Scope, data, and methodology
- Quarterly dataset covering 2000Q4 to 2023Q4.
- Endogenous variables:
  - y-o-y growth in nominal public sector wages (dlwg)
  - y-o-y growth in nominal private sector wages (dlwp)
  - CPI inflation (dlp)
- Public wages definition includes general government (28 percent of total number of employees) and SOEs (3 percent of total number of employees).
- Private wages: limited liability company (LLC) wages, covering about 50 percent of the total number of employees.
- Estimation approach:
  - Structural vector autoregression (SVAR) with a 4th-order lag polynomial (4 lags chosen).
  - Reduced-form VAR and recursive Cholesky decomposition for identification.
  - Baseline recursive ordering interpretation: public sector wages → private sector wages → inflation (public wages do not react contemporaneously within a quarter to private wages and inflation).
  - Exogenous controls: changes in the nominal exchange rate up to 4th order lag, seasonal dummies.
  - Diagnostic tests: Dickey-Fuller (stationarity at the 10 percent confidence level), lag selection (support for 4 lags FPE, AIC; 2 lags HQIC, SBIC), Lagrange multiplier (no serial correlation), eigenvalues inside unit circle (stability), Granger causality (mutual causality among three endogenous variables).

### Stylized facts and descriptive statistics
- Average growth rates (2001–2022):
  - Public sector wages: 15 percent
  - Private sector wages: 16 percent
  - Inflation (CPI): 8 percent
  - Implied average real growth of public and private wages: approximately 7-8 percent
- Labor productivity and output:
  - Mean labor productivity growth = 6.4 percent
  - Mean real GDP growth = 4.5 percent
  - Labor productivity growth exceeded mean real GDP growth.
- Sectoral and wage structure (2022):
  - Mining sector average wage: MNT 3.6 million per month; employment share: 5 percent.
  - Agriculture wage: MNT 1.1 million per month; employment share: 25 percent.
- Private wage premium:
  - Positive for most of the sample; approximately 30 percent private wage premium was eliminated within two quarters in the second half of 2023 following the public wage hike.

### Key empirical findings (impulse responses, elasticities, timing)
- Responses to 1 percentage point shocks:
  - A 1 percentage point shock to public sector wages → 0.2 percentage points increase in private sector wages in the first quarter; mostly insignificant in outer quarters (small and short-lived).
  - A 1 percentage point shock to private sector wages → about 0.2–0.3 percentage points higher public sector wages in quarters 1–6; insignificant from quarter 7 onward.
  - A 1 percentage point shock to private sector wages → 0.4 to 0.6 percentage points increase in inflation during the first year after the shock; effect diminishes and becomes statistically insignificant from the second year onward.
  - A 1 percentage point shock to public sector wages → 0.4–0.6 percentage points higher inflation in the second year following the shock (quarters 5–8); impact is smaller and insignificant in the first year.
- Elasticities (interpreted in paper):
  - Shock to private sector wages: peak elasticity on inflation = 0.6 (peaks within the first four quarters).
  - Shock to public sector wages: peak elasticity on inflation = 0.6 (peaks between the sixth and ninth quarters).
  - Private → public wage elasticity: 0.3 (peaks in the fourth quarter after the shock).
- Interpretation:
  - Private sector appears to play a more leading role in wage setting; public sector tends to catch up with private sector wages.
  - Delayed impact of public wage shocks on inflation consistent with public sector being smaller (about 30 percent of employment) and public wage increases less directly affecting production costs.

### Variance decomposition (contributions to forecast error variance)
- CPI inflation:
  - Own shocks explain roughly 80-97 percent of the variance in the first four quarters.
  - Shocks to private sector wages explain about 20 percent of the variance in the first two years (peaking within the second year).
  - Shocks to public sector wages contribute about 20 percent of the variance in the medium to long term (10-16 quarters).
- Public wages:
  - Own shocks explain roughly 80-99 percent of the variance in the first four quarters.
  - Contribution of shocks to private wages and inflation about 10-15 percent starting from the second year (quarters 5-16).
- Private wages:
  - Own shocks explain roughly 90-99 percent of the variance in the first four quarters.
  - Contribution of shocks to public wages and inflation about 10 percent starting from the second year (quarters 5-16).

### Quantitative scenario: 2023 supplementary budget public wage hike
- 2023 supplementary budget increased public wages permanently by 30-40 percent (35 percent on average) from July 2023 (2023Q3).
- Average growth of public wages over 2001-2022 = 15 percent.
- Inferred structural shock: 20 percent (35 percent minus 15 percent).
- Projected dynamic effect on inflation (IRF to the 20 percent structural shock):
  - Inflation projected to be 13.0 percentage points higher in 2025Q2 relative to the no-public-wage-shock scenario (peak).
  - The impact dissipates and becomes insignificant from 2026 onward.

### Robustness checks
- Alternative orderings: all six possible SVAR orderings yield very similar IRFs for inflation in response to a public sector wage shock.
- Endogenizing the exchange rate (fourth endogenous variable) with ordering public wages → private wages → exchange rate → inflation: IRF remains qualitatively unchanged, suggesting exchange rate does not amplify the impact of public wage shocks (consistent with Bank of Mongolia foreign exchange interventions).
- Additional controls included (no qualitative change in IRFs):
  - Dummies for IMF programs (2001, 2009, 2017 and RFI 2020), boom periods (2004, 2007, 2011, 2018, 2022), crisis periods (2009, 2016, 2020), parliamentary elections (2000, 2004, 2008, 2012, 2016, 2020).
  - Dummies for minimum wage increases; exogenous variables such as prices of copper, coal, and oil; money supply growth; GDP growth; inflation in China.
  - Core inflation substituted for headline inflation (core excludes 59 goods and services constituting 24.7 percent of the consumption basket).
- Results qualitatively unchanged across robustness checks.

### Policy implications and recommendations
- Public wage policy should be aligned with productivity growth to mitigate inflationary pressures:
  - Large discretionary and procyclical public wage increases (e.g., election-driven or revenue windfalls) risk amplifying macroeconomic volatility.
  - Large wage increases of 30-40 percent should be avoided as they create large wage-productivity gaps that can only be closed gradually.
- Favor predictable and productivity-linked public wage frameworks:
  - Move toward performance-based compensation for certain civil servants (noted as a positive government initiative that should be effectively implemented).
  - Focus public spending on productivity-enhancing expenditures to reduce volatility in wage dynamics.
- Coordination with monetary policy:
  - More predictable transmission from wage adjustments to inflation would bolster monetary policy efforts to maintain price stability.

*Interactions Between Public and Private Sector Wages and Inflation in Mongolia. Working Paper No. WP/2025/053.*

### References .............................................................................................................

### References — Interactions Between Public and Private Sector Wages and Inflation in Mongolia

### Scope, data, and methodology
- Quarterly dataset covering 2000Q4 to 2023Q4.
- Endogenous variables:
  - y-o-y growth in nominal public sector wages (dlwg)
  - y-o-y growth in nominal private sector wages (dlwp)
  - CPI inflation (dlp)
- Public wages definition includes general government (28 percent of total number of employees) and SOEs (3 percent of total number of employees).
- Private wages: limited liability company (LLC) wages, covering about 50 percent of the total number of employees.
- Estimation approach:
  - Structural vector autoregression (SVAR) with a 4th-order lag polynomial (4 lags chosen).
  - Reduced-form VAR and recursive Cholesky decomposition for identification.
  - Baseline recursive ordering interpretation:
    - public sector wages → private sector wages → inflation (public wages do not react contemporaneously within a quarter to private wages and inflation).
  - Exogenous controls: changes in the nominal exchange rate up to 4th order lag, seasonal dummies.
  - Diagnostic tests: Dickey-Fuller (stationarity at the 10 percent confidence level), lag selection (support for 4 lags FPE, AIC; 2 lags HQIC, SBIC), Lagrange multiplier (no serial correlation), eigenvalues inside unit circle (stability), Granger causality (mutual causality among three endogenous variables).

### Stylized facts and descriptive statistics
- Average growth rates (2001–2022):
  - Public sector wages: 15 percent
  - Private sector wages: 16 percent
  - Inflation (CPI): 8 percent
  - Implied average real growth of public and private wages: approximately 7-8 percent
- Labor productivity and output:
  - Mean labor productivity growth = 6.4 percent
  - Mean real GDP growth = 4.5 percent
  - Labor productivity growth exceeded mean real GDP growth.
- Sectoral and wage structure (2022):
  - Mining sector average wage: MNT 3.6 million per month; employment share: 5 percent.
  - Agriculture wage: MNT 1.1 million per month; employment share: 25 percent.
- Private wage premium:
  - Positive for most of the sample; approximately 30 percent private wage premium was eliminated within two quarters in the second half of 2023 following the public wage hike.

### Key empirical findings (impulse responses, elasticities, timing)
- Responses to 1 percentage point shocks:
  - A 1 percentage point shock to public sector wages → 0.2 percentage points increase in private sector wages in the first quarter; mostly insignificant in outer quarters (small and short-lived).
  - A 1 percentage point shock to private sector wages → about 0.2–0.3 percentage points higher public sector wages in quarters 1–6; insignificant from quarter 7 onward.
  - A 1 percentage point shock to private sector wages → 0.4 to 0.6 percentage points increase in inflation during the first year after the shock; effect diminishes and becomes statistically insignificant from the second year onward.
  - A 1 percentage point shock to public sector wages → 0.4–0.6 percentage points higher inflation in the second year following the shock (quarters 5–8); impact is smaller and insignificant in the first year.
- Elasticities (interpreted in paper):
  - Shock to private sector wages: peak elasticity on inflation = 0.6 (peaks within the first four quarters).
  - Shock to public sector wages: peak elasticity on inflation = 0.6 (peaks between the sixth and ninth quarters).
  - Private → public wage elasticity: 0.3 (peaks in the fourth quarter after the shock).
- Interpretation:
  - Private sector appears to play a more leading role in wage setting; public sector tends to catch up with private sector wages.
  - Delayed impact of public wage shocks on inflation consistent with public sector being smaller (about 30 percent of employment) and public wage increases less directly affecting production costs.

### Variance decomposition (contributions to forecast error variance)
- CPI inflation:
  - Own shocks explain roughly 80-97 percent of the variance in the first four quarters.
  - Shocks to private sector wages explain about 20 percent of the variance in the first two years (peaking within the second year).
  - Shocks to public sector wages contribute about 20 percent of the variance in the medium to long term (10-16 quarters).
- Public wages:
  - Own shocks explain roughly 80-99 percent of the variance in the first four quarters.
  - Contribution of shocks to private wages and inflation about 10-15 percent starting from the second year (quarters 5-16).
- Private wages:
  - Own shocks explain roughly 90-99 percent of the variance in the first four quarters.
  - Contribution of shocks to public wages and inflation about 10 percent starting from the second year (quarters 5-16).

### Quantitative scenario: 2023 supplementary budget public wage hike
- 2023 supplementary budget increased public wages permanently by 30-40 percent (35 percent on average) from July 2023 (2023Q3).
- Average growth of public wages over 2001-2022 = 15 percent.
- Inferred structural shock: 20 percent (35 percent minus 15 percent).
- Projected dynamic effect on inflation (IRF to the 20 percent structural shock):
  - Inflation projected to be 13.0 percentage points higher in 2025Q2 relative to the no-public-wage-shock scenario (peak).
  - The impact dissipates and becomes insignificant from 2026 onward.

### Robustness checks
- Alternative orderings: all six possible SVAR orderings yield very similar IRFs for inflation in response to a public sector wage shock.
- Endogenizing the exchange rate (fourth endogenous variable) with ordering public wages → private wages → exchange rate → inflation: IRF remains qualitatively unchanged, suggesting exchange rate does not amplify the impact of public wage shocks (consistent with Bank of Mongolia foreign exchange interventions).
- Additional controls included (no qualitative change in IRFs):
  - Dummies for IMF programs (2001, 2009, 2017 and RFI 2020), boom periods (2004, 2007, 2011, 2018, 2022), crisis periods (2009, 2016, 2020), parliamentary elections (2000, 2004, 2008, 2012, 2016, 2020).
  - Dummies for minimum wage increases; exogenous variables such as prices of copper, coal, and oil; money supply growth; GDP growth; inflation in China.
  - Core inflation substituted for headline inflation (core excludes 59 goods and services constituting 24.7 percent of the consumption basket).
- Results qualitatively unchanged across robustness checks.

### Policy implications and recommendations
- Public wage policy should be aligned with productivity growth to mitigate inflationary pressures:
  - Large discretionary and procyclical public wage increases (e.g., election-driven or revenue windfalls) risk amplifying macroeconomic volatility.
  - Large wage increases of 30-40 percent should be avoided as they create large wage-productivity gaps that can only be closed gradually.
- Favor predictable and productivity-linked public wage frameworks:
  - Move toward performance-based compensation for certain civil servants (noted as a positive government initiative that should be effectively implemented).
  - Focus public spending on productivity-enhancing expenditures to reduce volatility in wage dynamics.
- Coordination with monetary policy:
  - More predictable transmission from wage adjustments to inflation would bolster monetary policy efforts to maintain price stability.

*IMF WORKING PAPERS — Interactions Between Public and Private Sector Wages and Inflation in Mongolia*

### References

### References

### Studies on public-private wage differentials and co-movement
- Abdallah, C., Coady, D., and La-Bhus, F. J. (2023). Public-Private Wage Differentials and Interactions Across Countries and Time. International Monetary Fund Working Paper, WP/23/64.
- Afonso, A. and Gomes, P. (2014). Interactions between private and public sector wages. Journal of Macroeconomics, 39, 97-113.
- Giordano, R., Depalo, D., Coutinho Pereira, M., Eugène, B., Papapetrou, E., Perez, J. J., Reiss, L., and Roter, M. (2011). The public sector pay gap in a selection of European countries. European Journal of Political Economy, 27(4), 455-470.
- Lamo, A., Pérez, J. J., and Schuknecht, L. (2008). Public and private sector wages: Co-movement and causality. Applied Economics, 40(10), 1197-1209.
- Melly, B. and Timpe, C. (2017). Public sector wages and private sector wages: Co-movement and causality. Labour Economics, 49, 111-123.
- Anderson, D., Barkbu, B. B., and Lusinyan, L. (2014). Public wage spillovers: The role of social interactions. International Monetary Fund Working Paper, WP/14/50.
- Giordano, R., Depalo, D., Coutinho Pereira, M., Eugène, B., Papapetrou, E., Perez, J. J., Reiss, L., and Roter, M. (2011). The public sector pay gap in a selection of European countries. European Journal of Political Economy, 27(4), 455-470.
- Holmlund, B. (1993). Wage setting in private and public sectors in a model with endogenous government behavior. European Journal of Political Economy, 9(2), 213-232.
- Lamo, A. and Messina, J. (2010). Sectoral wage dynamics and inflation: What drives the differences between public and private employees? European Journal of Political Economy, 26(2), 280-300.

### Wage dynamics, nominal rigidity, and worker mobility
- Blanchard, O. J. and Katz, L. F. (1999). Wage dynamics: Reconciling theory and evidence. American Economic Review, 89(2), 69-74.
- Devereux, P. J. and Hart, R. A. (2006). Real wage cyclicality of job stayers, within-company job movers, and between-company job movers. Industrial and Labor Relations Review, 60(1), 105-119.
- Kahn, S. (1997). Evidence of nominal wage stickiness from microdata. American Economic Review, 87(5), 993-1008.

### Mongolia-specific studies and resource-boom context
- Barnett, S., Bersch, J., and Ojima, Y. (2012). Inflation dynamics in Mongolia: Understanding the roller coaster. International Monetary Fund Working Paper, WP/12/192.
- Doojav, G-O. (2009). Relationship between wages and income and inflation. Bank of Mongolia Working Paper.
- Sayour, N. and Schroder, M. (2021). The foreign direct investment job multiplier during a resource boom: Evidence from Mongolia. ADB Working Paper No. 642.

### Macroeconomic, policy, and broader labor-market literature
- Dornbusch, R., Fischer, S., and Startz, R. (2010). Macroeconomics. McGraw-Hill Education.
- Folster, S. and Henrekson, M. (2001). Growth effects of government expenditure and taxation in rich countries. European Economic Review, 45(8), 1501-1520.
- Gregory, R. G. and Borland, J. (1999). Recent developments in public sector labor markets. In O. Ashenfelter and D. Card (Eds.), Handbook of Labor Economics (Vol. 3, pp. 3573-3630). Elsevier.
- OECD. (2011). Economic Policy Reforms: Going for Growth. OECD Publishing.
- International Labour Organization (2018). India wage report: Wage policies for decent work and inclusive growth. ILO Decent Work Team for South Asia and Country Office for India. International Labour Office, Geneva.

*Interactions Between Public and Private Sector Wages and Inflation in Mongolia. Working Paper No. WP/2025/053.*

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_Source: https://www.imf.org/-/media/files/publications/wp/2025/english/wpiea2025053-print-pdf.pdf_