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The New Keynesian Phillips Curve and the Cyclicality of Marginal Cost

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Sandeep Mazumder

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Abstract

Several authors have argued that if the labor share of income is used as the proxy for real marginal cost, then the sticky-price version of the New Keynesian Phillips Curve does a good job of approximating US inflation dynamics. However, this paper argues that the labor share is an inappropriate measure of real marginal cost for two reasons: it is countercyclical whereas theory predicts marginal cost should be procyclical, and it employs a counterfactual assumption about the behavior of labor over the business cycle. Relaxing this assumption to a more realistic one leads to a measure of marginal cost that is markedly procyclical. Testing this improved measure of marginal cost then produces results that are contradictory to the entire underlying model of the NKPC. Thus I conclude that the NKPC fails to give a sound explanation of inflation dynamics.

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Paper provided by The Johns Hopkins University,Department of Economics in its series Economics Working Paper Archive with number 545.

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Date of creation: Sep 2008
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Handle: RePEc:jhu:papers:545

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