The Link between Labor Cost and Price Inflation in the Euro Area

66 Pages Posted: 5 Feb 2019

See all articles by Elena Bobeica

Elena Bobeica

European Central Bank (ECB)

Matteo Ciccarelli

European Central Bank (ECB)

Isabel Vansteenkiste

European Central Bank (ECB)

Date Written: February 4, 2019

Abstract

This paper documents, for the first time in a systematic manner, the link between labor cost and price inflation in the euro area. Using country and sector quarterly data over the period 1985Q1-2018Q1 we find a strong link between labor cost and price inflation in the four major economies of the euro area and across the three main sectors. The dynamic interaction between prices and wages is time-varying and depends on the state of the economy and on the shocks hitting the economy. Our results show that it is more likely that labor costs are passed on to price inflation with demand shocks than with supply shocks. However, the pass-through is systematically lower in periods of low inflation as compared to periods of high inflation. These results confirm that, under circumstances of predominantly demand shocks, labor cost increases will be passed on to prices. Coming from a period of low inflation, however, this pass-through could be moderate at least until inflation stably reaches a sustained path.

Keywords: inflation, pass-through, labor costs, structural VAR, euro area

JEL Classification: C32, E24, E31

Suggested Citation

Bobeica, Elena and Ciccarelli, Matteo and Vansteenkiste, Isabel, The Link between Labor Cost and Price Inflation in the Euro Area (February 4, 2019). ECB Working Paper No. 2235 (2019); ISBN 978-92-899-3497-8 , Available at SSRN: https://ssrn.com/abstract=3329196 or http://dx.doi.org/10.2139/ssrn.3329196

Elena Bobeica (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Matteo Ciccarelli

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Isabel Vansteenkiste

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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