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The impact of higher wages on output and inflation

Author

Listed:
  • Kai Christoffel
  • Julian Morgan

Abstract

In this article we examine the effects of wage increases using the ECB’s Area-Wide Model (AWM). The analysis implies that in all cases wage shocks lead to higher inflation. A wage shock may have a temporary positive impact on output only under a set of very unlikely conditions: (1) Wages rise temporarily and do not reflect any change in the wage bargaining process; (2) Economic agents correctly perceive this as temporary and do not change their behaviour; (3) Monetary policy does not react to the higher inflation induced by the rise in wages. In the likely event that these conditions were not fulfilled, the effects of the abandonment of wage moderation would imply falling investment, weak output and rising unemployment. JEL Classification: E5

Suggested Citation

  • Kai Christoffel & Julian Morgan, 2005. "The impact of higher wages on output and inflation," Research Bulletin, European Central Bank, vol. 3, pages 8-9.
    • Handle: RePEc:ecb:ecbrbu:2005:0003:3
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    Keywords

    inflation; monetary policy;

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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