U.S. Wage and Price Dynamics: A Limited-Information Approach

Sbordone, Argia M (2006): U.S. Wage and Price Dynamics: A Limited-Information Approach. Published in: International Journal of Central Banking , Vol. Volume, No. Number 3 (14 September 2006): pp. 155-191.

Abstract

This paper analyzes the dynamics of prices and wages using a limited-information approach to estimation. I estimate a two-equation model for the determination of prices and wages derived from an optimization-based dynamic model, where both goods and labor markets are monopolistically competitive, prices and wages can be reoptimized only at random intervals, and, when not reoptimized, can be partially adjusted to previous-period aggregate inflation. The estimation procedure is a two-step minimum-distance estimation, which exploits the restrictions that the model imposes on a time-series representation of the data. In the first step I estimate an unrestricted autoregressive representation of the variables of interest. In the second step, I express the model solution in the form of a constrained autoregressive representation of the data and define the distance between unconstrained and constrained representations as a function of the structural parameters that characterize the joint dynamics of inflation and labor share. This function summarizes the cross-equation restrictions between the model and the time-series representations of the data: I then estimate the parameters of interest by minimizing a quadratic function of that distance. I find that the estimated dynamics of prices and wages track actual dynamics quite well, and that the estimated parameters are consistent with the observed length of nominal contracts.

• Item Type: MPRA Paper
• Language: English
• Subjects: G - Financial Economics > G0 - General > G00 - General; G - Financial Economics > G0 - General

References

Altig, D., L. J. Christiano, M. Eichenbaum, and J. Lind´e. 2002. “Technology Shocks and Aggregate Fluctuations.” Unpublished. Amato, J. D., and T. Laubach. 2003. “Estimation and Control of an Optimization-Based Model with Sticky Prices and Wages.” Journal of Economic Dynamics and Control 27 (7): 1181–1215. Basu, S., and M. S. Kimball. 2000. “Long-Run Labor Supply and the Elasticity of Intertemporal Substitution for Consumption.” Unpublished, University of Michigan. Batini, N., B. Jackson, and S. Nickell. 2005. “An Open-Economy New Keynesian Phillips Curve for the U.K.” Journal of Monetary Economics 52 (6): 1061–72. Beveridge, S., and C. R. Nelson. 1981. “A New Approach to Decomposition of Economic Time Series into Permanent and Transitory Components with Particular Attention to Measurement of the ‘Business Cycle’.” Journal of Monetary Economics 7 (2): 151–74. Boivin, J., and M. Giannoni. 2005. “Has Monetary Policy Become More Effective?” Forthcoming in Review of Economics and Statistics. Vol. 2 No. 3 U.S. Wage and Price Dynamics 189 Calvo, G. A. 1983. “Staggered Prices in a Utility-Maximizing Framework.” Journal of Monetary Economics 12 (3): 383–98. Campbell, J. Y., and R. J. Shiller. 1987. “Cointegration and Tests of Present Value Models.” Journal of Political Economy 95 (5): 1062–88. Christiano, L., M. Eichenbaum, and C. Evans. 2005. “Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy.” Journal of Political Economy 113 (1): 1–45. Cogley, T., and T. J. Sargent. 2001. “Evolving Post-World War II U.S. Inflation Dynamics.” In NBER Macroeconomics Annual, ed. B. S. Bernanke and K. S. Rogoff, 331–73. ———. 2005. “Drifts and Volatilities: Monetary Policies and Outcomes in the Post WWII U.S.” Review of Economic Dynamics 8 (2): 262–302. Cogley, T., and A. M. Sbordone. 2005. “A Search for a Structural Phillips Curve.” Staff Report No. 203, Federal Reserve Bank of New York. Edge, R., T. Laubach, and J. Williams. 2003. “Productivity Slowdowns and Speedups: A Dynamic General Equilibrium Approach.” Unpublished, Board of Governors of the Federal Reserve System. Erceg, C. J., D. W. Henderson, and A. T. Levin. 2000. “Optimal Monetary Policy with Staggered Wage and Price Contracts.” Journal of Monetary Economics 46 (2): 281–313. Fuhrer, J., and G. Moore. 1995. “Inflation Persistence.” Quarterly Journal of Economics 110 (1): 127–59. Gagnon, E., and H. Khan. 2005. “New Phillips Curve under Alternative Technologies for Canada, the United States, and the Euro Area.” European Economic Review 49 (6): 1571–1602. Gal´ı, J., and M. Gertler. 1999. “Inflation Dynamics: A Structural Econometric Analysis.” Journal of Monetary Economics 44 (2): 195–222. Gal´ı, J., M. Gertler, and J. D. L´opez-Salido. 2001. “European Inflation Dynamics.” European Economic Review 45 (7): 1237–70. ———. 2005. “Robustness of the Estimates of the Hybrid New Keynesian Phillips Curve.” Journal of Monetary Economics. 52 (6): 1107–18. Guerrieri, L. 2006. “The Inflation Persistence of Staggered Contracts.” Journal of Money, Credit, and Banking 38 (2): 483–94. Hall, R. 1988. “The Relation Between Price and Marginal Cost in U.S. Industry.” Journal of Political Economy 96 (5): 921–47. Ireland, P. 1997. “A Small, Structural, Quarterly Model for Monetary Policy Evaluation.” Carnegie-Rochester Conference Series on Public Policy 47:83–108. King, R. J., and S. T. Rebelo. 1999. “Resuscitating Real Business Cycles.” In Handbook of Macroeconomics, Vol. 1B, ed. J. B. Taylor and M. Woodford, 927–1007. Elsevier Science. Kurmann, A. 2005. “Quantifying the Uncertainty about the Fit of a New Keynesian Pricing Model.” Journal of Monetary Economics 52 (6): 1119–34. Lind´e, J. 2005. “Estimating New-Keynesian Phillips Curves: A Full Information Maximum Likelihood Approach.” Journal of Monetary Economics 52 (6): 1135–49. Rotemberg, J., and M. Woodford. 1997. “An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy.” In NBER Macroeconomics Annual, ed. B. S. Bernanke and J. J. Rotemberg, 297–346. Rudd, J., and K. Whelan. 2005. “New Tests of the New- Keynesian Phillips Curve.” Journal of Monetary Economics 52 (6): 1167–81. Sbordone, A. M. 2001. “An Optimizing Model of U.S. Wage and Price Dynamics.” Working Paper Series 2001-10, Rutgers University. ———. 2002. “Prices and Unit Labor Costs: A New Test of Price Stickiness.” Journal of Monetary Economics 49 (2): 265–92. ———. 2005. “Do Expected Future Marginal Costs Drive Inflation Dynamics?” Journal of Monetary Economics 52 (6): 1183–97. Sims, C. A. 2001. “Comments on Papers by Jordi Gal´ı and by Stefania Albanesi, V.V. Chari and Lawrence J. Christiano.” Unpublished, Princeton University. Smets, F., and R. Wouters. 2003. “An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area.” Journal of the European Economic Association 1 (5): 1123–75. ———. 2005. “Comparing Shocks and Frictions in US and Euro Area Business Cycles: A Bayesian DSGE Approach.” Journal of Applied Econometrics 20 (2): 161–83. Taylor, J. B. 1980. “Aggregate Dynamics and Staggered Contracts.” Journal of Political Economy 88 (1): 1–23. ———. 1999. “Staggered Price and Wage Setting in Macroeconomics.”