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Do Unit Labor Cost Drive Inflation in the Euro Area?

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  • Sandra Tatierska

    (National Bank of Slovakia, Research Departmen)

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    Abstract

    The purpose of this study is to analyze the relationship between unit labor costs and inflation. We estimate an optimal price path model based on a New Keynesian Phillips Curve for eleven euro area countries individually, under the assumption that unit labor costs are proportional to marginal costs. We seek such a model which minimizes the distance between fitted and actual price level fluctuations, with parameters that satisfy theoretical restrictions. The econometric methodology used is a two-step approach method. Estimates show that in eight of the eleven euro area countries there is a plausible relationship between unit labor costs and price level dynamics. The average time needed to adjust prices in line with movements in unit labor costs is estimated to be around eight months. In the case of Slovakia the results indicate rather flexible prices.

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    Bibliographic Info

    Paper provided by Research Department, National Bank of Slovakia in its series Working and Discussion Papers with number WP 2/2010.

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    Length: 26 pages
    Date of creation: Dec 2010
    Date of revision:
    Handle: RePEc:svk:wpaper:1011

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    Related research

    Keywords: inflation; unit labor costs; NKPC; euro area; VAR;

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    1. Kurmann, Andre, 2005. "Quantifying the uncertainty about the fit of a new Keynesian pricing model," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1119-1134, September.
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