ECB – How steep is the Phillips curve?

From the ECB’s perspective, the development of wages is decisive for inflation.

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Dr. Marco Wagner

Commerzbank Economic Research

January 30 2024

Our research based on a new academic study suggests that wages start to rise very quickly once the shortage in the labour market has exceeded a certain threshold – in other words, the Phillips curve is non-linear. Indeed, the labour market is exceptionally tight at the moment and this is unlikely to change in the foreseeable future, especially as the working population is shrinking in many countries and participation rates are already relatively high. Our analysis favours upside risks and inflation settling at a higher level. This should make it difficult for the ECB to cut interest rates significantly, as many expect.

Markets expect interest rate cuts soon, but the ECB is looking at wages

Most analysts expect inflation rates to continue to fall. According to the Bloomberg survey, they are already forecasting inflation or core inflation of 2¼% by the end of 2024. In view of this, the markets expect the central bank to cut interest rates soon and significantly. For the ECB, wage trends are a key factor for inflation and therefore monetary policy in the coming months. In our view, the tight labour market will lead to further strong wage increases.

The Phillips curve could be much steeper than assumed ...

Many analysts base their assessment of a further fall in (core) inflation in the coming months on the assumption of a relatively flat Phillips curve, i.e. that lower unemployment will hardly cause wage or consumer price inflation to rise. However, a new study by two economists from the University of Bern and Brown University near Bostson suggests that wages start to rise very quickly once labour market shortages exceed a certain threshold – i.e. the Phillips curve is non-linear (Benigno und Eggertsson, 2023). The authors prove this for the USA in their empirical study by looking at data back to the 1960s – unlike most previous studies – and thus also including earlier episodes of exceptional labour market shortages. In the USA, this was the case already at the end of the 1960s, when there was more than one vacancy for every jobseeker (Chart 1). According to this indicator, the labour market is still very tight today.