Our periodic review of three academic papers. The first one (“On the Distributional Effects of Inflation and Inflation Stabilization” by Del Negro et al. (2024)) studies the effects of inflation and inflation stabilization on different segments of the population. The second paper (“The Wage-Price Pass-Through Across Sectors: Evidence from the Euro Area” by Ampudia (2024)) investigates the relationship between wage growth and producer prices across different sectors within the Euro area. The final paper (“Linkage between Wage and Price Inflation in Japan” by Ueno (2024)) examines the evolving relationship between wage and price inflation in Japan, particularly before and after the COVID-19 pandemic.
Paper #1: Del Negro et al. (2024)
“On the Distributional Effects of Inflation and Inflation Stabilization” by NY Fed economists Marco Del Negro, Keshav Dogra, Pranay Gundam, Donggyu Lee, and Brian Pacula studies the effects of inflation and inflation stabilization on different segments of the population. Using a Heterogeneous Agent New Keynesian (HANK) model, the authors show that cost-push inflation negatively affects most households, with the strongest effects on the poorest households. Aggressive inflation stabilization policies exacerbate these effects, further harming those households.
What the paper does and main results
The paper builds on a HANK model, which combines features of traditional New Keynesian models with the reality of wealth and income inequality among households. The authors focus on how cost-push shocks and monetary tightening impact various wealth and income groups, using data up to Q3 2023. The model captures the standard aggregate responses to monetary policy shocks—where increases in interest rates lead to declines in output and inflation—but highlights the differing impacts on households across the wealth distribution.
Inflation, when driven by supply shocks, disproportionately harms poorer households because they rely more heavily on labor income and have less financial wealth to cushion against rising prices. The left panel of Figure 1 shows the effects of a supply shock on welfare across the wealth distribution. The intuition is simple: because the shock decreases real wages and increases unemployment, it particularly hurts “hand-to-mouth” households that have little savings and are highly dependent on their current income. On the other hand, the wealthiest households, who derive a significant portion of their income from profits, benefit from these shocks as falling labor costs eventually lead to higher corporate profits.
Aggressive monetary tightening can fight inflation but worsens the situation for poor households. When monetary policy aggressively targets inflation, the model shows that while inflation may be brought under control, the resulting economic contraction disproportionately affects lower-income households. The right panel of Figure 1 illustrates this result. Following a monetary contraction, poor households face even higher unemployment and higher real rates on their debt, making them worse off compared to households in the middle of the wealth distribution, who suffer little in terms of real rates and little in terms of foregone profits.
Figure 1. Distributional effects of a cost-push shock (left panel) and a monetary shock (right panel) in the HANK model of Del Negro et al. (2024). The effect of the shock is measured in consumption-equivalent terms.
A critique of the paper
The distributional effects of inflation are likely different than suggested in the paper. Indeed, inflation can also be driven by demand-side shocks, and these shocks can benefit lower income households through lower unemployment and (possibly) higher real wages. In such a case, contractionary monetary policy is the standard tool of choice, whereas the typical trade-off between real activity and inflation caused by supply shocks is already making monetary policy a less effective tool on aggregate, even before considering distributional consequences. Overall, it seems fair to say that Covid inflation was the result of both supply and demand-driven shocks, making the conclusions of the paper less straightforward.
Policy implications
Monetary policy alone may not be able to address inflation in a welfare-optimal way. While central bankers have good reasons to focus on aggregate indicators as their policy targets, the distributional effects of inflation are non-negligible. Additional government interventions may therefore be needed to address inequality concerns. Fiscal intervention and monetary-fiscal policy coordination are worth considering. This need not be complicated: Targeted fiscal transfers in case of unemployment or real wage losses may already provide a useful cushion against inflation for the poorest households while being unlikely to stimulate aggregate demand significantly enough to complicate the central bank’s inflation stabilization agenda.
Paper #2: Ampuda, Lombardi, and Renault (2024)
“The Wage-Price Pass-Through Across Sectors: Evidence from the Euro Area” by Miguel Ampudia (ECB), Marco Jacopo Lombardi (BIS), and Théodore Renault (ECB), investigates the relationship between wage growth and producer prices across different sectors within the Euro area. The pass-through from wages to prices is significant, with a 50% pass-through rate observed after three years. This effect varies across sectors, being more pronounced but slower to materialize in private services than in industrial sectors.
What the paper does and main results
The study focuses on the euro area’s sectoral wage-price pass-through using sector-specific data from 41 sectors over the period 2009Q1-2023Q2. The key variables include producer prices, wages, and input prices. These data are used to estimate how changes in wages affect producer prices across different sectors using a fixed-effects panel regression.
There is significant wage-price pass-through, but its strength and speed differ across sectors. The average pass-through stabilizes around 50% after three years: A 1% increase in wages leads to a 0.5% increase in producer prices. The pass-through is particularly strong in private services compared to industrial sectors, but takes longer to fully materialize in services, see Figure 2.
Figure 2. Wage-price pass-through for all sectors (left panel) and industry versus private services (right panel). The axis shows the increase in producer prices (in percent) following a 1% increase in wages.
Sectoral differences in wage-price pass-through are due to heterogeneity in labor intensity, international import competition, and sales destination. For instance, and as expected, higher labor intensity leads to a greater pass-through in services. Increased international import competition reduces the pass-through in industrial sectors. Sales destination also matters: The wage-price pass-through is strong for domestic sales but weaker for exports, possibly because stronger international competition gives firms less ability to pass on domestic cost increases to international customers.
The wage-price pass-through has increased over the Covid period, especially in the service sector. Pass-through estimates reached 48% over one year, which is stronger than before Covid when such estimates were not significantly different from zero. Estimates for industrial sectors are weaker at 41% compared to 91% pass-through for services. Therefore, recent economic developments seem to have altered (increased) the pass-through from wage growth to price inflation.
A critique of the paper
The paper provides valuable insights into the sectoral differences in wage-price pass-through, particularly in the context of the euro area. The use of granular sectoral data allows for a detailed understanding of how wages influence prices in different sectors. However, the reliance on sectoral data over a relatively short time frame (2009-2023) may limit the generalizability of the findings, especially in the context of unprecedented economic conditions during the COVID-19 pandemic.
While the study effectively highlights the role of labor intensity and international competition in shaping wage-price dynamics, it remains unclear how the pass-through depends on the source of wage changes. For example, the pass-through may differ between wage productivity shocks and labor force participation shocks. Additionally, the pass-through could also depend on other structural factors such as policy interventions in the labor market or on the consumer side. Therefore, the results of the paper should be taken with a grain of salt.
Policy implications
Euro area inflation can remain around (or a bit above target). Wage growth has started to moderate in the Euro area but remains higher than pre-Covid. Unsurprisingly, given the estimated pass-through, services inflation has not slowed down yet. Taken at face value, the results of the paper caution against concluding that inflation is fully dominated in the Euro area, where it might remain around (or a bit above) target.
Paper #3: Ueno (2024)
A recent Bank of Japan working paper (Linkage between Wage and Price Inflation in Japan) by Yoichi Ueno examines the evolving relationship between wage and price inflation in Japan, particularly before and after the COVID-19 pandemic. While wage and price inflation decoupled around 1998, there has been a partial recoupling in the post-pandemic period.
What the paper does and main results
The paper estimates trend components in inflation measures using a multivariate unobserved components model with stochastic volatility and outlier adjustments. The author uses sectoral data on wages and prices from 1981 to 2023 and a standard unobserved component model. The model assumes that the observed price and wage series are functions of their own idiosyncratic trend, transitory components, and a common component. Based on the estimated trends, the paper measures the link between different inflation components through correlations.
The correlation between wage and price inflation has been high before 1997 but turned insignificant after, until surging again during the Covid pandemic. The first horizontal panel (that is, the first three horizonal lines) of the table in Figure 3 shows these correlations, along with t-statistics and p-values. Similar results are obtained for the correlation between goods prices and wages in the manufacturing sector (second panel) and services prices and wages in the non-manufacturing sector (third panel). Overall, this suggests there has been a recoupling between wages and prices during and after Covid.
Figure 3. HAR test on the correlation between trends in different price and wage inflation measures, for different samples.
A critique of the paper
While the paper identifies trends and correlations, it could benefit from a deeper exploration of the causal mechanisms behind the observed decoupling and recoupling of wages and prices. The author links the importance of wage indexation to the volatility of the common component of price and wage inflation and constructs a narrative around this idea, but a solid causal identification scheme would provide more insights.
Policy implications
The partial recoupling of wages and prices in the post-pandemic period suggests that inflationary pressures could become more persistent than expected, particularly in the services sector. In recent months/quarters some measures of wage growth have accelerated. Conditional on the results of this paper, consumers price inflation should be expected to remain persistent and above target.