Functional income distribution and aggregate demand in the Euro area

An increase in the wage share has contradictory effects on the subaggregates of aggregate demand. Private consumption expenditures ought to increase because wage incomes typically are associated with higher consumption propensities than capital incomes. Investment expenditures ought to be negatively affected because investment will positively depend on profits. Net exports will be negatively affected because an increase in the wage share corresponds to an increase in unit labour costs and thus a loss in competitiveness. Therefore, theoretically, aggregate demand can be either wage-led or profit-led depending on how these effects add up. The results will crucially depend on how open the economy is internationally. The paper estimates a post-Kaleckian macro model incorporating these effects for the Euro area and finds that the Euro area is presently in a wage-led demand regime. Implications for wage policies are discussed. Copyright The Author 2008. Published by Oxford University Press on behalf of the Cambridge Political Economy Society. All rights reserved., Oxford University Press.