Bending the Curves: Wages and Inflation

As economic slack continues to be absorbed and the labour market tightens, wage growth and inflation could increase faster than expected, which would suggest convexity in their Phillips curves. This note investigates whether there is convexity in the Phillips curves for Canadian wage growth and inflation by testing different empirical approaches over the post-inflation-targeting period. We conclude that while there is some evidence that the relationship between wage growth—as indicated by the Bank of Canada wage-common measure—and the output gap is non-linear in Canada, there is no clear evidence of a convex relationship between inflation and the output gap. The presence of downward nominal wage rigidity could likely explain these results. The risk of a sharp increase in CPI inflation therefore appears to be small over the projection horizon (2018–20) since the Canadian economy is expected to experience only modest excess demand.