ECB Working Paper: Wage Phillips Curve in the Euro Area Is Alive and Well

2 December 2021

By David Barwick – FRANKFURT (Econostream) – A European Central Bank working paper published Thursday said its findings confirmed the validity for the euro area of the Phillips curve.

The working paper - the views presented in which the ECB said ‘do not necessarily reflect’ those of the ECB – looked at the problem that in the relationship between unemployment and wage growth rates, the former’s role can be influenced by endogenous factors that are neglected, such as supply shocks or monetary policy.

The two usual ways of dealing with this are subject to deficiencies, according to the paper, which advocated an alternative that, ‘rather than trying to explicitly account for the endogeneity present in the model … provides bounds on how “extreme” the endogeneity present in the model has to be before central qualitative conclusions from a regression analysis are overturned.’

Applying the proposed estimation method, the paper said the results supported inclusion of proxies for supply shocks and argued against using instrumental variables frequently relied on in this context to establish causality.

In particular, the paper said, estimating a Philips curve fitting historical euro area data, results were obtained that the authors said they interpreted ‘as evidence supporting the view that the wage Phillips curve in the euro area is alive and well.’

Monetary authorities in recent years have tended to highlight a weaker link between inflation and unemployment, under which circumstances, according to Executive Board member Fabio Panetta last June, ‘anchoring inflation expectations matters even more.’

Speaking on background, one ECB insider remarked to Econostream recently that the Phillips curve in the euro area was still alive as far as wages but not as far as prices.

Chief Economist Philip Lane in September 2019 gave a speech on the Phillips curve at the ECB in which he called the structural Phillips curve ‘a useful framework’ and said that the ‘reduced-form empirical relation between slack and inflation provides a helpful contribution to the suite of forecasting models that we use at the ECB.’