ECB Second-Round Wage-Inflation Transmission Simulator

Macro Drivers Eurozone Calibrated

Scenarios:

Negotiated Wage Growth 3.4%

Annual growth in negotiated Eurozone compensation per employee.

Labor Productivity Growth 1.2%

Output per hour worked offsetting wage cost pressures.

Profit Margin Absorption 45%

Share of Unit Labor Cost increase absorbed by firm markups.

External Shock / Energy 0.3%

Contribution of imported energy/goods to headline costs.

5y Inflation Expectations 2.1%

Market/survey anchor (5y5y forward inflation swap proxy).

Unit Labor Costs (ULC)

+2.2%

Δ Wages − Δ Productivity

Forecast Core HICP

2.1%

Target: 2.0% Symmetric

Second-Round Index

0.18

Moderate / Absorbed

Implied ECB DFR

2.75%

Deposit Facility Rate Stance

Transmission Cascade & Margin Buffer

Wage Impulse Margin Buffer Consumer Price HICP

8-Quarter Forward Transmission Path

Wages HICP Inflation ECB Policy Rate

Governing Council Assessment: Moderate Baseline

Eurozone wage pressures remain well-contained. High corporate profit margin absorption (45%) cushions unit labor costs from directly spilling into consumer services and core HICP. No self-sustaining wage-price spiral detected.

"Wage growth remains moderate, and we do not see second-round effects taking hold in the Euro area economy." — Olli Rehn, ECB Governing Council member & Governor of Bank of Finland.

1. Unit Labor Cost Mechanics

Unit Labor Cost (ULC) measures the average cost of labor per unit of total output produced. When wage growth outstrips labor productivity gains, ULC expands:

ULC Growth ≈ Δ Wage Rate − Δ Output Per Worker

As long as productivity rises in tandem with negotiated wages, cost push pressure on final consumer prices remains negligible.

2. Corporate Profit Margin Buffer

A critical post-pandemic structural feature of the Eurozone is the margin buffer. When firms absorb elevated wage costs via lower unit profits rather than passing them forward to retail prices, second-round inflation is severed.

Pass-Through = ULC Growth × (1 − Margin Absorption %)

Olli Rehn and ECB staff projections emphasize this profit compression mechanism as the anchor for headline disinflation.

3. Second-Round Spiral Thresholds

Second-round effects occur when temporary supply shocks or catch-up wage bargaining become entrenched in long-term inflation expectations, triggering reciprocal rounds of markup and wage hikes.

Spiral Index = (ULC Pass-Through + Expectation Premium) × Feedback

An index < 0.35 denotes stable absorption; > 0.65 signals severe wage-price spiral contagion requiring tight monetary policy.