Europe’s Wage-Price Puzzle
IMF Blog, November 11, 2019
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Bibliographic details
- Authors: Richard Varghese
- Published: November 11, 2019
Summary
- Author: Richard Varghese
- November 11, 2019
- Context: Chart of the Week exploring why robust wage growth in Europe has not translated into higher inflation; draws on Chapter 2 of the Regional Economic Outlook: Europe.
Key findings
- The link between wage growth and inflation in Europe has weakened considerably in the decade since the global financial crisis.
- More precisely, the impact of wage growth on core inflation has been only two-thirds as strong as in the period before the crisis.
- Despite wages rising at a robust pace, especially in the European Union’s newer member states, inflation has barely risen.
Mechanisms explaining the weaker wage-to-price passthrough
- Inflation expectations:
- Firms are more reluctant to raise prices in response to an increase in labor costs when inflation is low and inflation expectations are well anchored.
- Firms see higher wage costs as temporary, so they limit price increases expecting competitors to do the same.
- Competitive pressures:
- Firms’ pricing strategies depend significantly on their exposure to competition, domestic or from abroad.
- Sectors with more overseas competition, such as manufacturing, are less likely to raise prices in response to higher wage growth than the services sector.
- Corporate profitability:
- The passthrough of wage growth to inflation is significantly lower when corporate profits are healthy.
- Profitable firms can absorb a higher wage bill without raising prices, especially if they want to preserve market share.
Policy implications and outlook
- With inflation expectations near historic lows, rising competitive pressures, and comfortable profit margins, it is likely that robust wage growth will not meaningfully spur inflation in the near future.
- Monetary policy:
- These findings suggest that monetary policy in many European countries should remain accommodative for longer to lift inflation durably to its target.
- Financial stability risk:
- Policymakers must be on guard for financial instability that could arise when an extended period of low rates encourages greater risk taking.
Source: IMF Blog post "Europe’s Wage-Price Puzzle" by Richard Varghese, November 11, 2019.
