Inflationary dynamics of labour market activity: Evidence from the Czech Republic

This paper provides an in-depth investigation into the intricacy of inflation dynamics in the Czech Republic, with particular emphasis on the influence exerted by labor market activity. The research employed principal component analysis and the local projections methodology proposed by Jorda (2005) in the context of the Phillips curve framework, followed by the extension of the analysis via the introduction of a nuanced state dependence dimension that recognizes that the impact of labor market activity on inflation may be contingent upon the broader economic situation. Our findings revealed the statistically significant impact of labor market activity on inflation. Specifically, a one standard deviation increase in the labor market activity component leads to an accumulated increase in inflation of approximately 3 percentage points over a three-year horizon. Our non-linear model uncovered the pivotal interaction between state dependence and the impact on inflation. The findings revealed that during expansionary periods, labor market pressures can be effectively managed for a limited period, albeit with a slight escalation in prices. However, over an extended period, the labor market is susceptible to encountering constraints that lead to markedly higher inflation rates - almost twice as high as those observed during recessionary periods. We subjected our benchmark results to extensive robustness verification.