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Testing price equations

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  • Fair, Ray C.

Abstract

How inflation and unemployment are related in both the short run and long run is perhaps the key question in macroeconomics. This paper tests various price equations using quarterly U.S. data from 1952 to the present. Issues treated are the following. (1) Estimating price and wage equations in which wages affect prices and vice versa versus estimating "reduced-form" price equations with no wage explanatory variables. (2) Estimating price equations in (log) level terms, first difference (i.e., inflation) terms, and second difference (i.e., change in inflation) terms. (3) The treatment of expectations. (4) The choice and functional form of the demand variable. (5) The choice of the cost-shock variable. The results suggest that the best specification is a price equation in level terms imbedded in a price-wage model, where the wage equation is also in level terms. The best cost-shock variable is the import price deflator, and the best demand variable is the unemployment rate. There is some evidence of a nonlinear effect of the unemployment rate on the price level at low values of the unemployment rate. Many of the results in this paper are contrary to common views in the literature, but the empirical support for them is strong.

Suggested Citation

  • Fair, Ray C., 2008. "Testing price equations," European Economic Review, Elsevier, vol. 52(8), pages 1424-1437, November.
  • Handle: RePEc:eee:eecrev:v:52:y:2008:i:8:p:1424-1437
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    References listed on IDEAS

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    1. Jeremy Rudd & Karl Whelan, 2006. "Can Rational Expectations Sticky-Price Models Explain Inflation Dynamics?," American Economic Review, American Economic Association, pages 303-320.
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    Cited by:

    1. Fair, Ray C., 2012. "Has macro progressed?," Journal of Macroeconomics, Elsevier, vol. 34(1), pages 2-10.
    2. Ray C. Fair, 2010. "Possible Macroeconomic Consequences of Large Future Federal Government Deficits," NBER Chapters,in: Tax Policy and the Economy, Volume 25, pages 89-108 National Bureau of Economic Research, Inc.
    3. Dufour, Jean-Marie & Khalaf, Lynda & Kichian, Maral, 2013. "Identification-robust analysis of DSGE and structural macroeconomic models," Journal of Monetary Economics, Elsevier, vol. 60(3), pages 340-350.
    4. Malikane, Christopher, 2014. "A new Keynesian triangle Phillips curve," Economic Modelling, Elsevier, vol. 43(C), pages 247-255.
    5. Malikane, Christopher & Mokoka, Tshepo, 2012. "Monetary policy credibility: A Phillips curve view," The Quarterly Review of Economics and Finance, Elsevier, vol. 52(3), pages 266-271.
    6. Malikane, Christopher, 2012. "The microfoundations of the Keynesian wage-price spiral," MPRA Paper 42921, University Library of Munich, Germany, revised 29 Nov 2012.
    7. Xu, Yingying & Chang, Hsu-Ling & Lobonţ, Oana-Ramona & Su, Chi-Wei, 2016. "Modeling heterogeneous inflation expectations: empirical evidence from demographic data?," Economic Modelling, Elsevier, vol. 57(C), pages 153-163.

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    Keywords

    Price equations NAIRU;

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