This paper demonstrates that the behavior of the conventional Phelps-Taylor model of overlapping wage contracts stands in stark contrast with important features of U.S. macro data for inflation and output. In particular, the Phelps-Taylor specification implies far too little inflation persistence. The authors present a new contracting model, in which agents are concerned with relative real wages, that is data-consistent. In a specification that nests both models, the authors resoundingly reject the conventional contracting model but cannot reject the new contracting model. Copyright 1995, the President and Fellows of Harvard College and the Massachusetts Institute of Technology.
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