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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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References

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  1. Julio J. Rotemberg & Michael Woodford, 1999. "The Cyclical Behavior of Prices and Costs," NBER Working Papers 6909, National Bureau of Economic Research, Inc.
  2. Argia M. Sbordone, 2001. "Prices and Unit Labor Costs: A New Test of Price Stickiness," Departmental Working Papers, Rutgers University, Department of Economics 200112, Rutgers University, Department of Economics.
  3. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 93-17, Board of Governors of the Federal Reserve System (U.S.).
  4. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, American Economic Association, vol. 91(2), pages 232-237, May.
  5. Jeremy Rudd & Karl Whelan, 2001. "New tests of the New-Keynesian Phillips curve," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2001-30, Board of Governors of the Federal Reserve System (U.S.).
  6. Jordi Gali & Mark Gertler, 2000. "Inflation Dynamics: A Structural Econometric Analysis," NBER Working Papers 7551, National Bureau of Economic Research, Inc.
  7. Marvin Goodfriend & Robert G. King, 2001. "The case for price stability," Working Paper, Federal Reserve Bank of Richmond 01-02, Federal Reserve Bank of Richmond.
  8. Argia Sbordone, 2002. "An optimizing model of U.S. wage and price dynamics," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.
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Citations

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Cited by:
  1. Ken Kuttner & Tim Robinson, 2008. "Understanding the Flattening Phillips Curve," Department of Economics Working Papers, Department of Economics, Williams College 2008-15, Department of Economics, Williams College.
  2. Kenneth F. Wallis, 2004. "Comparing Empirical Models of the Euro Economy," Econometric Society 2004 Australasian Meetings, Econometric Society 14, Econometric Society.
  3. Nuno Alves, 2004. "A Flexible View on Prices," Working Papers, Banco de Portugal, Economics and Research Department w200406, Banco de Portugal, Economics and Research Department.
  4. O'Reilly, Gerard & Whelan, Karl, 2004. "Has euro-area inflation persistence changed over time?," Working Paper Series, European Central Bank 0335, European Central Bank.
  5. Tillmann, Peter, 2005. "The New Keynesian Phillips Curve in Europe: does it fit or does it fail?," Discussion Paper Series 1: Economic Studies 2005,04, Deutsche Bundesbank, Research Centre.
  6. Karl Whelan & Jeremy Rudd, 2003. "Can Rational Expectations Sticky-Price Models Explain Inflation Dynamics?," Computing in Economics and Finance 2003, Society for Computational Economics 181, Society for Computational Economics.
  7. 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).
  8. Coenen, Gunter, 2007. "Inflation persistence and robust monetary policy design," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 31(1), pages 111-140, January.
  9. 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, Central Bank of Chile, vol. 6(2), pages 77-94, August.

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