Causality between Prices and Wages: VECM Analysis for EU-12

The literature on causality as well as the empirical evidence clearly shows that there are two opposing groups of economists, who support different hypotheses with respect to the flow of causality in the price-wage causal relationship. The first group argues that causality runs from wages to price, whereas the second argue that effect flows from prices to wages. Nonetheless, there is at least some consensus that researchers conclusions may be contingent on the type of data employed, applied econometric model, or even that the relationship may vary through economic cycles. This paper empirically examines the pricewage causal relationship in EMU, by using OLS and VECM analysis, and also it provides robust evidence in support of a bilateral causal relationship between prices and wages, both in long-run as well as in the short-run. Prior to designing and estimating the econometric model we have performed stationarity tests for the employed price, wage and productivity variables. Additionally, we have also specified the model taking into account the lag order as well as the rank of co-integration for the co-integrated variables. Furthermore, we have also applied respective restrictions on the parameters of the estimated VECM and finally model robustness checks indicate that results are statistically robust. Although far from closing the issue of causality between prices and variables, this paper at least provides some fresh evidence for the case of EMU.