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Does the Labour Share of Income Drive Inflation?

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  • Rudd, Jeremy

    (Federal Reserve Board)

  • Whelan, Karl

    (Central Bank and Financial Services Authority of Ireland)

Abstract

Recent years have seen a proliferation in research aimed at assessing monetary policy rules using macroeconomic models built from explicit micro-foundations. In many versions of these models, pricing behaviour is described by a ``new-Keynesian Phillips curve,'' which relates inflation to expected future inflation and a driving variable related to production costs. Woodford (2001) has presented evidence that the new-Keynesian Phillips curve fits the empirical behaviour of U.S. inflation well when the labour income share is used as a driving variable, but fits poorly when deterministically detrended output is used. He concludes that the output gap---the deviation between actual and potential output---is better captured by the labour income share, in turn implying that central banks should raise interest rates in response to increases in the labour share. We show that the empirical evidence generally suggests that the labour share version of the new-Keynesian Phillips curve is a very poor model of U.S. price inflation. We conclude that there is little reason to view the labour income share as a good measure of the output gap, or as an appropriate variable for incorporation in a monetary policy rule.

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Bibliographic Info

Paper provided by Central Bank of Ireland in its series Research Technical Papers with number 2/RT/02.

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Length: 21 pages
Date of creation: Jun 2002
Date of revision:
Handle: RePEc:cbi:wpaper:2/rt/02

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  1. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  2. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
  3. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  4. Sbordone, Argia M., 2002. "Prices and unit labor costs: a new test of price stickiness," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 265-292, March.
  5. Julio J. Rotemberg & Michael Woodford, 1999. "The Cyclical Behavior of Prices and Costs," NBER Working Papers 6909, National Bureau of Economic Research, Inc.
  6. Rudd, Jeremy & Whelan, Karl, 2005. "New tests of the new-Keynesian Phillips curve," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1167-1181, September.
  7. Marvin Goodfriend & Robert G. King, 2001. "The case for price stability," Working Paper 01-02, Federal Reserve Bank of Richmond.
  8. Argia M. Sbordone, 2001. "An Optimizing Model of U.S. Wage and Price Dynamics," Departmental Working Papers 200110, Rutgers University, Department of Economics.
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Citations

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Cited by:
  1. Ken Kuttner & Tim Robinson, 2008. "Understanding the Flattening Phillips Curve," RBA Research Discussion Papers rdp2008-05, Reserve Bank of Australia.
  2. Jeremy Rudd & Karl Whelan, 2006. "Can Rational Expectations Sticky-Price Models Explain Inflation Dynamics?," American Economic Review, American Economic Association, vol. 96(1), pages 303-320, March.
  3. O'Reilly, Gerard & Whelan, Karl, 2004. "Has euro-area inflation persistence changed over time?," Working Paper Series 0335, European Central Bank.
  4. Coenen, Günter, 2003. "Inflation persistence and robust monetary policy design," Working Paper Series 0290, European Central Bank.
  5. Nuno Alves, 2004. "A Flexible View on Prices," Working Papers w200406, Banco de Portugal, Economics and Research Department.
  6. Peter Tillmann, 2009. "The New Keynesian Phillips curve in Europe: does it fit or does it fail?," Empirical Economics, Springer, vol. 37(3), pages 463-473, December.
  7. Wallis, Kenneth F., 2004. "Comparing empirical models of the euro economy," Economic Modelling, Elsevier, vol. 21(5), pages 735-758, September.
  8. William Baeza L. & Pablo García., 2003. "Medidas Alternativas de Brechas en Modelos de Inflación," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 6(2), pages 77-94, August.
  9. Holmberg, Karolina, 2006. "Derivation and Estimation of a New Keynesian Phillips Curve in a Small Open Economy," Working Paper Series 197, Sveriges Riksbank (Central Bank of Sweden).

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