BIS central bankers’ speeches  13  Table 1: Estimated wage Phillips curves including measures of expected inflation Nominal wage growth(a) (1) (2) Wage growth (t-1)(a) Productivity growth(a) Unemployment gap Labour share (t-1) 2-year household inflation expectations (t-1)(b)  -0.31*** (0.09) 0.36*** (0.11) -2.22*** (0.36) -0.52*** (0.14) 1.13*** (0.35)  5-year breakeven inflation rate (t-1)(c) Interaction with inflation targeting dummy Constant  Observations R-squared  -0.35*** (0.09) 0.31*** (0.10) -2.23*** (0.36) -0.33** (0.17)  -0.14 (0.29) 0.02 (0.02)  1.02*** (0.28) -0.04 (0.29) 0.03* (0.02)  105 0.50  101 0.50  Sources: Barclays Basix; Bloomberg; Bank calculations. Notes: Estimated using quarterly data between 1987 Q1 and 2014 Q4. (a) Annualised quarter-on-quarter growth. (b) Excludes the period between 2012 Q2 and 2013 Q1 due to effects of the CPAC review on RPI-linked financial instruments. (c) Barclays Basix 2-year head household expectations. It is possible to simulate the effects of lower inflation expectations on the MPC’s February Inflation Report projections using the estimated wage relationships from Table 1, together with the Bank’s general equilibrium forecasting model. Chart 25 shows the effect on wages and inflation. Wage growth ends up around 0.3 percentage points lower at the twoyear horizon, while inflation is around 0.4 percentage points lower, than in the MPC’s central projections. Taking seriously recent falls in inflation expectations would add to the scale and duration of potential downside risks to UK inflation in the period ahead.
Chart 16: IMF estimates of global price Phillips curve slopes Interquartile range  Median 2.0  1.5  1.0  0.5  0.0 1961 1967 1974 1980 1986 1993 1999 2006 Sources: IMF (2013). Chart 17 shows the results from this exercise. Wages and prices are both weaker throughout: at the two-year horizon, wage growth is 0.6 percentage points lower than in the February Inflation Report, while inflation is 0.2 percentage points lower. In other words, a flatter Phillips curve would generate a downside risk to the inflation outlook at the policy horizon. A final explanation for the wage puzzle is that weak wages are signalling that the output or unemployment gap is larger than currently estimated. There are a number of potential sources of such additional slack, including greater spare capacity in firms, a greater willingness among workers to increase their average hours, or a lower long-term rate of unemployment than is currently estimated by the Bank.10 How much additional slack? Imagine you asked yourself how much slack would be needed to resolve the wage puzzle of the past few years. Even with a very conservative estimate of the Phillips curve slope, the implied degree of slack could be somewhere close to 4%, materially above the MPC’s current central view of slack of around ½%.