Euro area labor market resilient as real wages adjust to inflation

The study's key findings reveal a novel resilience in employment relative to output during the post-pandemic period, sharply contrasting with historical recessions.

Crucially, the erosion of real wages played a pivotal role in sustaining labour demand, a stark difference from the 1970s when real wages rose strongly.

Furthermore, the transmission of monetary policy proved asymmetric, with output reacting more forcefully than employment.

These results collectively underscore the central importance of real wage adjustment and evolving wage-setting institutions in shaping the labour market's capacity to withstand shocks.

As ECB President Christine Lagarde noted in August 2025, "This cycle has proven to be original in striking ways," challenging familiar patterns from past monetary policy cycles.

Unlike the 1970s, where large energy price increases led to output and employment losses with rising real wages due to indexation, the recent period shows a substantial erosion of real wages.

This suggests a different adjustment mechanism.

The paper investigates this divergence by combining long-span euro area macroeconomic data (1970–2025) with a structural VAR analysis.

This method disentangles the roles of aggregate demand and supply, monetary policy, and factor-substitution shocks, explaining the observed decoupling between output and employment.

The study also highlights how the breakdown of 'divine coincidence' in New Keynesian models, due to wage rigidities, introduces a trade-off for central banks.