Because wage setting is forward looking, expected future inflation enters as an explanatory variable. Finally, unemployment, relative to the natural rate of unemployment, enters as a measure of tightness in the labour market.25 Quarterly growth in AWE private sector regular pay (annualised) is used as an explanatory variable. Unfortunately, this is only available from January 2000, so observations of quarterly average pay growth begin in 2000 Q2. The last observation is 2015 Q3. Unemployment is measured by the quarterly average of the LFS unemployment rate. Inflation expectations are measured using general public inflation expectations measures taken from the Barclays Basix index. Variations on this simple specification are also estimated. First, annual spot inflation, lagged one quarter, is used to replace the inflation expectations. That is on account of the strong collinearity between survey measures of household inflation expectations and actual inflation outturns. Second, the Bank of England’s agents’ scores for recruitment difficulties are included as an additional gauge of labour market frictions, which could reflect the ease or otherwise of labour market matching, and which are not captured by contemporaneous measures of headline unemployment. Third, productivity growth (in heads) is included as an additional explanatory variable. Table A1 contains the estimation results. The model in column (1) of the table contains a very simple Wage Phillips Curve (WPC), relating pay to its lag and to unemployment. The WPC slope of around unity is highly statistically significant and the simple model explains around 40% of the variation in wage growth.

Column (2) adds lagged inflation as a crude measure of inflation expectations, and column (3) further adds the recruitment difficulties measure. Both enter with the expected sign and indicate that a 1 percentage point rise in inflation or a 1-point rise in the agents’ score would tend to correlate with rises in wage growth of between ½ and ¾ percentage point. The coefficient on unemployment remains at around unity. Columns (4) and (5) add measures of inflation expectations. Relative to (3), the inflation expectations measure in model (4) adds little explanatory power and enters with the “wrong” sign, possibly indicating multicollinearity. Dropping inflation, in column (5), restores a role for inflation expectations with the expected sign. Model (5) has overall marginally less explanatory power than model (3). Columns (6) and (7) add productivity growth to the model. In moving from model (4) to (6), there is a small increment in explanatory power, and productivity growth enters significantly, although the coefficient on recruitment difficulties falls and is now estimated less precisely. Inflation expectations continue to enter with the “wrong” sign and their coefficient is estimated  25  In Gali’s model, unemployment is positive under flexible prices and wages on account of a steady state wage mark-up, which captures inefficiencies in wage setting. Unemployment can move away from this rate in the short run, during which period nominal wages and prices are rigid, in response to shocks to the economy. 18  BIS central bankers’ speeches  imprecisely.