The relationship between wage inflation and unemployment rate: evidence from the 15 european union member-states

Abstract

The purpose of this paper is to investigate the relationship between wage inflation and unemployment rate in the 15 European member-states. For this purpose 15 similar wage determination equations were estimated for each member state. Each equation was relating wages inflation to the unemployment gap between the actual unemployment rate and the NAWRU, prices inflation, labour productivity, and lagged wage inflation, and thus, making use of a modified structure of a Phillips curve wage inflation equation. Treating the NAWRU as a time varying unobserved stochastic process, a state-space maximum likelihood estimation method-using Kalman filter where the state variable was a random walk-was followed in order to estimate the 15 equations. The estimates, using annual data from 1961 to 1999, suggest that the extent and direction of changes in the NAWRU over the periods 1961-80, 1981-90 and 1991-99 is mixed across the EU member states. Similarly, employing a dynamic multipliers analysis, it is seen that the sensitivity of wages inflation with respect to changes in price inflation, in labour productivity and in unemployment gap considerably varies among the 15 EU member states. Thus, the application of "common" policies across the 15 European member states may be questionable because of the different effects of these policies on the various economies.