How are wage developments passed through to prices in the euro area? Evidence from a BVAR model

Abstract

ABSTRACT This paper explores the transmission mechanism between wages and prices in the euro area. While labour costs account for notable parts of companies’ costs and should, hence, be of relevance for the developments in inflation, the empirical literature suggests only a loose link between the variables. From a theoretical perspective there are at least two broad categories of channels of how labour costs and prices can be linked, namely the supply-side channel of cost push inflation and the demand-side channel of demand pull inflation. This paper develops a BVAR model for the wage-price pass-through in the euro area and analyses how supply and demand shocks that trigger these two types of inflation are transmitted between wages and prices along the cost side of the economy. The main results can be summarized as follows: First, the wage-price pass-through in the euro area is shock-dependent. Second, the pass-through of wages to prices appears to have undergone some changes over time. Third, the pass-through appears to differ across HICP components. Finally, historical decompositions show that the identified shocks are of relevance for the movements of wages and prices in the euro area.