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European Wage Dynamics and Spillovers

Author/Editor:

Yuanyan Sophia Zhang

Publication Date:

July 19, 2019

Electronic Access:

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Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary:

Wage rises have remained stubbornly low in advanced Europe in recent years, but, at the same time, newer EU members are experiencing rapid wage acceleration. This paper investigates the drivers of this wage divergence. Econometric analysis using error correction models suggests that wage growth responds more quickly to changes in unemployment in the newer EU members than in advanced Europe, where wages are more closely related to inflation and inflation expectations in the short run, implying greater inertia in nominal wage rises in advanced Europe. In the years after the global crisis, this inertia contributed to the build up of a real wage overhang relative to sharply slowing labor productivity, which subsequently dragged on nominal wage rises even as unemployment began to decline. Spillovers of subdued wage growth between euro area countries also weighed on wage rises in advanced Europe.


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