The relationship between inflation and wage growth in the Irish economy

Abstract

This paper tests for the long-run and short-run relationship between prices and wages in the Irish economy over the 1975–92 period. Using recent econometric techniques in the analysis of time series, we conclude that there is a long-run equilibrium relationship between prices, wages and an excess demand variable in agreement with the expectations augmented Phillips curve theory of inflation. Making use of error-correction equations in order to study the short-run dynamics, we find that the long-run relationship between prices and wages is due to Granger causality running from wage inflation to price inflation. In addition, the predictive ability of excess demand is weak with respect to wage inflation but very strong with respect to price inflation. These results imply (a) relatively strong evidence in favour of a mark-up price equation consistent with the expectations augmented Phillips curve theory of inflation, and (b), very weak evidence for the predictive power of past inflation and the output gap for wages, i.e., a wage-type Phillips curve effect. In other words, the results provide strong support for the claim that inflation in Ireland has cost-push elements and very weak support for the existence of demand-pull elements.