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Prices and Unit Labor Costs: A New Test of Price Stickiness

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  • Argia M. Sbordone

    ()
    (Rutgers University)

Abstract

This paper investigates the predictions of a simple optimizing model of nominal price rigidity for the aggregate price level and the dynamics of inflation. I compare the model's predictions with those of a perfectly competitive, flexible price `benchmark' model (corresponding to the model of pricing assumed in standard real business cycle models), and evaluate how much the introduction of nominal rigidities improves the model's fit with the data. The model's predictions are derived using only the firms optimal pricing problem; taking as given the paths of nominal labor compensation, labor productivity, and output, I determine the implied path of prices predicted by the model. Because prices are not a stationary series, I present my results in terms of the predicted path of the price/unit labor cost ratio, where the parameters characterizing such paths are chosen to maximize the fit with the data. I find that while the evolution of prices relative to unit labor costs is quite different from what would be predicted by the flexible-price `benchmark' model, a simple model of nominal price rigidity delivers an extremely close approximation both of the price/unit labor cost ratio and of the inflation series, even under a very simple approach to the measurement of marginal costs.

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Bibliographic Info

Paper provided by Rutgers University, Department of Economics in its series Departmental Working Papers with number 199822.

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Date of creation: 19 Oct 2001
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Handle: RePEc:rut:rutres:199822

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Keywords: Inflation; Phillips Curve; Unit Labor Cost;

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  1. Jordi GalĂ­ & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
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  3. Campbell, John Y & Shiller, Robert J, 1987. "Cointegration and Tests of Present Value Models," Journal of Political Economy, University of Chicago Press, vol. 95(5), pages 1062-88, October.
  4. Mark W. Watson, 1991. "Measures of Fit for Calibrated Models," NBER Technical Working Papers 0102, National Bureau of Economic Research, Inc.
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  8. Fuhrer, Jeffrey C, 1997. "The (Un)Importance of Forward-Looking Behavior in Price Specifications," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(3), pages 338-50, August.
  9. Fuhrer, Jeff & Moore, George, 1995. "Inflation Persistence," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 127-59, February.
  10. Diebold, Francis X & Ohanian, Lee E & Berkowitz, Jeremy, 1998. "Dynamic Equilibrium Economies: A Framework for Comparing Models and Data," Review of Economic Studies, Wiley Blackwell, vol. 65(3), pages 433-51, July.
  11. King, Robert G & Watson, Mark W, 1996. "Money, Prices, Interest Rates and the Business Cycle," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 35-53, February.
  12. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  13. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper 98-05, Federal Reserve Bank of Richmond.
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  16. Argia M. Sbordone, 2001. "An Optimizing Model of U.S. Wage and Price Dynamics," Departmental Working Papers 200110, Rutgers University, Department of Economics.
  17. Alexander L. Wolman, 1999. "Sticky prices, marginal cost, and the behavior of inflation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 29-48.
  18. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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  23. Arturo Estrella & Jeffrey C. Fuhrer, 2002. "Dynamic Inconsistencies: Counterfactual Implications of a Class of Rational-Expectations Models," American Economic Review, American Economic Association, vol. 92(4), pages 1013-1028, September.
  24. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
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