Striking a Bargain: Narrative Identification of Wage Bargaining Shocks

By Žymantas Budrys, PhD researcher at DSE Alma Mater Studiorum – Bologna University, Mario Porqueddu, Senior Economist, Prices and Costs Division at European Central Bank, and Andrej Sokol, Senior Economist at Bank of England. Originally published at VoxEU.

Workers and employers bargain over the surplus income generated by an employment relationship. This column uses information about key events in Germany relevant for wage negotiations, like labour strikes and the introduction of a minimum wage, to pinpoint changes in bargaining power between workers and employers. It finds that such wage bargaining ‘shocks’ are important drivers of unemployment and inflation and that their effect on wages is almost fully reflected in prices. Furthermore, they reduce the vacancy rate and increase firms’ profits and the labour share of income in the short run, but not in the long run.

>Workers and employers bargain over the surplus income generated by an employment relationship, most notably in terms of wages. Wage-setting reflects broader macroeconomic developments, but it is also affected by shifts in bargaining power that are not directly observed. We propose a novel approach to identify exogenous variation (compared with other factors such as demand and supply shocks) in bargaining power from the data, using information about key events relevant for wage negotiations. We then study its effects on the macroeconomy.

In Germany, the country we focus on, a number of historical events arguably constitute positive wage bargaining shocks that improve workers’ bargaining power, such as the introduction of a statutory minimum wage in 2015 and a number of labour disputes led by the prominent union IG Metall. Minimum wage policy acts as a direct shift of bargaining power in favour of workers, and collective bargaining rounds that involve the threat of, or actual, strikes also boost workers’ bargaining power.

We find that positive wage bargaining shocks propagate to the economy through higher unemployment and lower output. The effects on unemployment are very persistent, whereas the effects on output are comparatively short-lived, mostly fading within three years. We also find that, for Germany, bargaining shocks explain around a quarter of changes in inflation and unemployment at longer horizons. Furthermore, the so-called pass-through of higher wages to prices following a wage bargaining shock is close to total. It thus provides a rationale for monetary policymakers to closely monitor factors influencing wage bargaining outcomes.

Identifying wage bargaining shocks

Bargaining power is unobserved and is an ‘umbrella’ term for various factors – ranging from personal preferences to the extent of unionisation and the sequencing of bargaining steps – that determine how the surplus of a work relationship is split between parties. In a canonical search and matching framework (Pissarides 2000), bargaining power is controlled by a parameter that seeks to capture all factors determined outside the model. In such a model, an increase in bargaining power allows workers to obtain higher wages, but vacancies drop as firms are less willing to hire owing to increased costs, leading to a gradual increase in unemployment.

Crucially, such an outcome for unemployment very much depends on the specifics of the assumed model. A different bargaining framework, a more complex modelling set-up, or different parameter values can completely alter the conclusions – and with them any policy recommendations. We therefore seek to rely as little as possible on theory in our identification of wage bargaining shocks, and instead exploit information available from recent historical events. We employ a structural vector autoregression (SVAR) model that relies on sign restrictions (also used in previous studies of wage bargaining shocks, e.g. Foroni et al. 2018, Conti and Nobili 2019, Galí and Gambetti 2019), but also on minimum wage policy shifts and labour strikes for identification.

Minimum wage introduction

At the beginning of 2013 German political parties declared a shared intention to introduce a binding minimum wage, and legislation in that sense came into force in August 2014. Compared with wage floors in other European countries, the initial minimum wage rate of €8.50, adjusted for purchasing power, was the third largest. Moreover, around 10.7% of the workforce (four million employees) had wage rates below the new threshold and were eligible for the minimum wage rate.

Major industrial actions

We also treat major industrial disputes as wage bargaining shocks. We apply stringent criteria to select strikes suitable for our identification purposes. We focus on strikes where (1) a union is viewed as the winner of a negotiation round, and (2) anecdotal evidence suggests that wage increases would have been much less favourable to workers in the absence of a strike (threat). Moreover, we only consider cases where (3) the strike is an ‘economic strike’, meaning that it is focused on wage increases or better working conditions. We also choose (4) significant and costly strikes: in Germany, the legislative framework governing strikes encourages unions to call warning strikes that are typically short and induce only minor production losses for the firm; instead, we focus on full-day strikes. Finally, we only consider (5) major labour market conflicts involving IG Metall, the union for the metal and electricity industry.

We identify three events that fully match our criteria. These occurred in the second quarter of 1995, the third quarter of 2002, and the second quarter of 2018. We also include another event, in the second quarter of 1999. Unlike the others, this fourth event did not result in a full-day strike, but instead ended with a compromise reached two hours after the deadline to authorise a strike. We observe non-negligible wage increases after IG Metall industrial disputes, as shown in Figure 1.

Figure 1 Nominal wages around selected IG Metall industrial strikes

Notes: The grey area shows the month of the actual wage increase, agreed between IG Metall and the association of employers. Basic Pay Rates (BPR) is an indicator compiled on a monthly basis by the Deutsche Bundesbank that summarises developments in wages under collective agreements covering over half of the German workforce (Deutsche Bundesbank 2020); BPR (MoM) is its monthly growth rate and BPR (QoQ) is its quarterly growth rate. The Wages and Salaries series is the quarterly growth rate of wages and salaries per employee based on national accounts.

However, strikes are not completely independent events. In fact, calls for strikes and most negotiated wage increases typically reflect unions’ reactions to improving economic conditions. For example, historical sources emphasise that IG Metall reacted to past and expected developments in wages, workers’ low purchasing power, a better economic situation, and rising profitability (Gesamt Metall 2018). But strikes are not entirely predictable either. For one thing, while the incidence of strikes may coincide and correlate with favourable economic conditions, industrial action is still pretty rare. It is subject to legal barriers and usually viewed as a last resort in wage negotiations, owing to the potential unemployment and reputational costs for all social partners involved.

To establish exogeneity, we investigate the predictability of the full-day strikes using an event study of the stock market performance of firms whose employees are represented by IG Metall, following the approach of Neumann (1980), Becker and Olson (1986), and Kramer and Vasconcellos (1996), among others.

Strikes are harmful and costly for firms. Future profitability may suffer for a number of reasons, such as lost or delayed production owing to stoppages or the expectation of a higher wage bill owing to increased wage demands. Thus, strikes may reduce the valuation of a company, and if capital markets are efficient and strikes were not anticipated, the lower valuation should be reflected in the firm’s stock price. We find that, on average, stock returns fall by around 0.7-0.95% over the four days up to and including the strike, thus corroborating our identification assumptions.

Wage bargaining shocks and the macroeconomy

We estimate and identify an SVAR model that includes five macroeconomic variables: the GDP deflator, real wages and salaries per hour, the unemployment rate, hours worked per employee, and real GDP per capita. For estimation, we rely on standard Bayesian techniques (see Litterman 1986, Kadiyala and Karlsson 1997, Bańbura et al. 2010, among others), supplemented with a long-run prior (Giannone et al. 2019). The latter is particularly useful for German data, where reunification and a number of structural reforms in the early 2000s induced some trending behaviour for otherwise rather stable variables, notably unemployment and average hours worked.

Figure 2 shows the impulse responses (i.e. how variables react) to a positive wage bargaining shock that improves workers’ bargaining power. The increase in real wages, which is around 0.2 percentage points on impact, lasts for about two years following the initial shock. The pattern mostly reflects the dynamics of nominal wages, only partially offset by a slower-moving response of domestic prices. Indeed, the unexpected increase in the wage bill raises the price level by 0.15 percentage points on impact, which then remains above its steady state level for three to four years.

Average working hours fall by about 0.1 percentage points within two quarters after the shock, but then experience a long-lasting reversal that peaks at 0.1 percentage points above the steady state after around three years, while the unemployment rate gradually increases following the shock, reaching a peak of 0.15 percentage points after around two years, and with an even more gradual return to the steady state. Output per capita falls on impact and reaches a trough of around −0.4 percentage points after three quarters, then reverses the decline and returns to the steady state within three years.

The pattern of impulse responses indicates that German firms first react to increased labour costs by adjusting prices and reducing average hours worked. With time, firms then also adjust the size of their workforce and unemployment increases as a result, while those still in employment end up working longer hours. This is consistent with existing evidence about the relative importance of the adjustment in average worked hours in the euro area compared with the United States (see Ohanian and Raffo 2011, Bulligan et al. 2019).

Wage bargaining shocks are an important driver of the business cycle in Germany. A breakdown of forecast error variance shows that around 16% of the contemporaneous variation in real wages is explained by the shock, and it still explains approximately 6% at the ten-year horizon. The shock is an important driver of GDP deflator inflation, explaining almost a quarter of its variation. In the long run, the shock also accounts for a fifth of the variation in the unemployment rate. Focusing on an interesting historical episode, we also find that following the announcement and introduction of a minimum wage in 2014-15 (the same event also used for our narrative identification), wage bargaining shocks led to a persistent increase of around 0.25% in hourly real wages, or roughly 0.5% in nominal terms, lasting until early 2016).

Figure 2 Impulse responses to a positive wage bargaining shock

Notes: The figure shows impulse responses to a positive wage bargaining shock for the baseline model. Bands show 68% credible sets of the posterior distribution.


We revisit the identification of wage bargaining shocks in an SVAR model using narrative information for Germany. We propose to use historical events, namely the introduction of a minimum wage as well as a number of industrial disputes, which are both economically relevant for aggregate wage dynamics and plausibly exogenous due to exogenous variation in bargaining power. Our findings suggest that wage bargaining shocks are an important source of macroeconomic fluctuations, and our model’s quantification of the impact of the minimum wage introduction in Germany is in line with and complements existing micro-econometric evidence. Given the similarities between wage bargaining institutions in many economies (such as the existence of some form of national minimum wage, widespread union coverage and a relatively high degree of regulation of the wage-setting process (e.g. Du Caju et al. 2009), our methods and findings are of broader applicability and relevance.

Authors’ Note: This column first appeared as a Research Bulletin of the European Central Bank. The authors gratefully acknowledge the comments of Alexandra Buist and Alexander Popov. The views expressed here are those of the author and do not necessarily represent the views of Bloomberg LP, the European Central Bank, or the Eurosystem.


  1. IG Metall is generally viewed as a trend-setter for wage bargaining activity in Germany, owing to its significance in terms of union coverage (the number of workers covered by collective bargaining) and historical dominance. The union is the largest in Germany and in fact the largest in Europe, representing around 3.5 million employees (see Eurofound 1999).
  2. We also estimate a set of wage Phillips curves to investigate whether wage dynamics can be adequately explained by macroeconomic developments for the quarters in which industrial disputes occur. In our baseline specification, we find that quarterly wage growth is on average 0.7 percentage points in excess of what macroeconomics factors would warrant for those quarters, suggesting that our selected events do indeed coincide with positive surprise effects related to an increase of bargaining power and are economically relevant for wage dynamics.
  3. Note that the impulse response of the price level is inferred from the cumulative response of inflation.
  4. This corroborates existing estimates of the resulting increase in the nominal wage bill, which range between 0.4% and 0.55% (Deutsche Bundesbank 2018, Mindestlohnkommission 2018, Caliendo et al. 2019).

References available at the original.

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About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.


  1. Ken

    The way I see minimum wage fights is the way thanos saw iron man’s efforts to beat him down – so much for so little.

    1. Ignacio

      The opposite is quite true: with very little effort, the PMC can impose small burdens to everybody but with great benefits for them. (Not only about wages). The bargaining power is extremely assymetric. Unionization should be a must.

  2. Jeff Z

    Notably absent is a discussion of the timing of when contracts expire. Companies routinely lay off workers when business conditions are bad.

    Ignacio, your point about unionization is a good one. But it does raise the question about the function of unions currently in a capitalist society. Some marxists, especially those at the world socialist website, see unions in their current form as a way to discipline the workforce and maintain management control. This becomes a crucial question for all workers in light of the United Auto workers recent scandals.

    1. Kouroi

      From my dealings with my union, I can attest that “unions in their current form as a way to discipline the workforce and maintain management control”…

  3. Jeremy Grimm

    I read this post to its conclusion, and then read it again and attempted to figure out what it said. Then I read it again. In my opinion, the authors of this post have accomplished some wondrously obtuse writing. They may have a future creating communications for the Fed.

    This statement from the post is interesting: “We therefore seek to rely as little as possible on theory in our identification of wage bargaining shocks, and instead exploit information available from recent historical events. We employ a structural vector autoregression (SVAR) model that relies on sign restrictions…”
    I believe that means the authors intend to examine data to extract inferences deliberately avoiding the unpleasant way results using constructed models “very much depends on the specifics of the assumed model”. The authors focus on the unobserved parameter ‘bargaining power’ typically used “to capture all factors determined outside the model [exogenous]”. They appear to regard ‘bargaining power’ as the chief fudge factor making assumed models inconsistent and unreliable. By applying “standard Bayesian techniques” to the data available from “a long-run prior” they intend to estimate the the unobserved variable. This is starting to sound like an exercise in black box system identification and modeling: “System Identification Toolbox™ provides MATLAB® functions, Simulink® blocks, and an app for constructing mathematical models of dynamic systems from measured input-output data.” [ref MathWorks Documentation] An effort like this is sometimes employed as a first step in designing an optimal controller to obtain optimal performance from a system. Using their approach the authors were able to make calculations like: “0.1 percentage points”, “0.15 percentage points”, “around −0.4 percentage points” and related them to the dynamic systems performance in the time domain. Move over 19th Century physics and make room for model systems theory, the kool new approach to neoclassical economics.

    Footnote #2 is a little troubling — “We also estimate a set of wage Phillips curves to investigate whether wage dynamics can be adequately explained by macroeconomic developments…” I have no idea what Footnote #2 says. I think the authors believe their new and improved model of wage dynamics based on data incorporates an estimate of the unobserved parameter bargaining power that corrects for the average 0.7 percentage points shortfall in the wage growth macroeconomics factors alone calculate — or something like that. Phillips curves?

    The final conclusion: “Our findings suggest that wage bargaining shocks are an important source of macroeconomic fluctuations, and our model’s quantification of the impact of the minimum wage introduction in Germany is in line with and complements existing micro-econometric evidence.” I think the finding that wage bargaining shocks can cause macroeconomic fluctuations could have been found without any fancy modelling effort. I think the second half of this conclusion is a way of saying their model is well tweaked to fit the data they used to generate it. The authors close: “…our methods and findings are of broader applicability and relevance.” I rather hope not. I believe their methods and findings offer little information that might be of value in making economic policy. An economy is not a fixed system to be controlled and optimized. It is also a system that policy can change. Optimization, if attempted, requires defining optimization criteria, which are also a matters for policy. I believe their methods and findings occult understanding the structure of the economy.

    1. Yves Smith

      The very fact that they call it “bargaining shocks” means the model presupposes a return to equilibrium, that is the impact will dissipate and things will revert to the old trend eventually. Which means they believe the shock or enough shocks can’t affect the trend.

    2. Carla

      @Jeremy Grimm — Thank you. I do not have the patience for as thorough a reading as you gave this piece, so I am grateful to you for it, and for your analysis.

  4. Jeremy Grimm

    Going over this post yet again, it sure seems like the data indicates strikes are bad for business and do not help workers all that much — leading to increased unemployment, fewer hours, and result in an increase in real wages of around 0.2 percentage points that fades away after 2 years as the increases in domestic price level erode the gain. That sounds like wage push inflation. Figure 2 seems to be saying that wage increases all settle back to their earlier level and what is going on with price levels? “Wage bargaining shocks are an important driver of the business cycle in Germany”, huh? If my guess is right that these guys want to control the economy using calculations based on their model, and the authors believe wage bargaining has a big impact on the business cycle, and they seem to calculate that minimum wage laws result in temporary increases in real wages but long term decreases in employment levels and productivity and one of these guys works for the European Central Bank and the other works for the Bank of England … I guess that definitely rules out England and Europe as destinations for relocation. I hope I am just confused about what this post says, and how to interpret it.

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