Labour Productivity and Unit Labour Costs Impact on Inflation: What Are the Implications for Monetary Policy?
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This chapter explores the role of labour productivity and unit labour costs (ULC) in transmitting inflationary pressures and repo rate responses to inflation. Evidence shows that increases in labour productivity play an important role in dampening inflationary pressures directly and indirectly via the propagation effects. Labour productivity and ULC exert opposite effects on size of the adjustments of the repo rate to positive inflation shocks. Positive labour productivity shock lowers inflation and the increase in unit labour costs results in a quick recovery in inflation. Furthermore, persistent labour productivity shocks lower inflation for prolonged periods. The implication is that inflationary pressures would subside more when there are persistent improvements in labour productivity.
However, in the presence of positive inflation shocks and weak labour productivity growth does not mitigate inflationary pressures. The degree to which labour productivity neutralizes inflationary pressures shows the speed and magnitude of the repo rate adjustment to positive inflation shocks.