## Europe’s Wage-Price Puzzle

_IMF Blog, November 11, 2019_

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**Canonical URL:** [Europe’s Wage-Price Puzzle](https://www.imf.org/en/blogs/articles/2019/11/11/europes-wage-price-puzzle)

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## Bibliographic details
- Authors: Richard Varghese
- Published: November 11, 2019

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### 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.*

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## References

- [Regional Economic Outlook: Europe](https://www.imf.org/en/Publications/REO/EU/Issues/2019/10/24/REO-EUR-1119)
- [https://www.imf.org/wp-content/uploads/2019/11/eng-nov-6-reoch2-1.png](https://www.imf.org/wp-content/uploads/2019/11/eng-nov-6-reoch2-1.png)

_Source: https://www.imf.org/en/blogs/articles/2019/11/11/europes-wage-price-puzzle_