Wage and Price Dynamics in Portugal Wage and Price Dynamics in Portugal Wage Dynamics Network Wage Dynamics Network

This paper investigates the persistence of aggregate wages and prices in Portugal assuming a model of a unionized economy with imperfect competition. An impulse response analysis is conducted where the structural shocks are identi ed by taking into account the long-run properties of the model, as well as the cointegrating and weak-exogeneity properties of the system. Real wages and wage ination emerge as especially persistent following an import price shock, while price ination is more persistent following an unemployment shock. At the business cycle horizon variation in the forecast errors of wages is attributable mainly to unemployment shocks (about 80 percent), whereas variation in the forecast errors of prices is attributable mainly to import price shocks (about 60 percent) and to unemployment shocks (around 20 percent). Productivity shocks explain somewhat less than 10 percent of the variation in forecast errors of wages and prices. JEL classi cation codes: C32, C51, E31, J30. Key Words: wages, prices, impulse response function, persistence, structural errorcorrection model. 4 ECB Working Paper Series No 945 October 2008 Non-technical summary Wage and price rigidities are widely recognised as a crucial issue for macroeconomics and notably for monetary policy. In the real world, the existence of price and nominal wage rigidities may be expected to translate into persistent responses of real wages, price and wage ination to shocks hitting the economy. Evaluating the degree of persistence of such responses is thus, an issue of paramount importance. This paper evaluates persistence of wages and prices in the Portuguese economy, within a structural vector error-correction model, by assuming a model where wages are determined through collective bargaining and prices are set by imperfectly competitive rms. As expected, we nd that the relative persistence of wages and prices is shock speci c. In particular, real wages are especially persistent following a permanent import price shock such that only 53 percent of the total disequilibrium dissipates in rst two years after the shock. This compares to 66 percent in the case of a permanent unemployment shock and 69 percent in the case of a permanent productivity shock. Similar conclusions hold for wage ination. In contrast, price ination is more persistent following a permanent unemployment shock (only 42 percent of the total disequilibrium dissipates in the rst two years, compared to 53 percent in the case of a permanent import price shock). These results accord with intuition, because an import price shock impacts directly on domestic prices and only indirectly on wages, while an unemployment shock impacts directly on wages and mainly indirectly on prices through lower wages. At the business cycle horizon, variation in the forecast-errors of wages are attributable mainly to unemployment shocks (about 80 percent) whereas variation in the forecasterrors of prices are attributable mainly to import price shocks (around 60 percent) and to unemployment shocks (around 20 percent). Productivity shocks explain a relatively small proportion of the forecast-errors in both wages and prices (less than 10 percent). 5 ECB Working Paper Series No 945 October 2008