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Inflation and Unit Labor Cost

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  • Robert G. King

    (Boston University, Department of Economics)

  • Mark W. Watson

    (Department of Economics and Woodrow Wilson School, Princeton University)

Abstract

We study two decompositions of inflation, , motivated by a New Keynesian Pricing Equation. The first uses four components: lagged , expected future , real unit labor cost ( ), and a residual. The second uses two components: fundamental inflation (discounted expected future ) and a residual. We find large low-frequency differences between actual and fundamental inflation. From 1999-2011 fundamental inflation fell by more than 15 percentage points, while actual inflation changed little. We discuss this discrepancy in terms of the data (a large drop in labor's share of income) and through the lens of a canonical structural model (Smets-Wouters (2007)).

Suggested Citation

  • Robert G. King & Mark W. Watson, 2012. "Inflation and Unit Labor Cost," Boston University - Department of Economics - Working Papers Series WP2012-005, Boston University - Department of Economics.
    • Handle: RePEc:bos:wpaper:wp2012-005
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