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Do search frictions matter for inflation dynamics?

  • Krause, Michael U.
  • Lopez-Salido, David J.
  • Lubik, Thomas A.

We assess the empirical relevance for inflation dynamics of accounting for the presence of search frictions in the labor market. The new Keynesian Phillips curve explains inflation as being mainly driven by current and expected future marginal costs. Recent empirical research has emphasized different measures of real marginal costs to be consistent with observed inflation persistence. We argue that, allowing for search frictions in the labor market, real marginal cost should also incorporate the cost of generating and maintaining long-term employment relationships, along with conventional measures, such as real unit labor costs. In order to construct a synthetic measure of real marginal costs, we use newly available labor market data on worker finding and separation rates that reflect hiring and firing costs. We then estimate a new Keynesian Phillips curve by generalized method of moments (GMM) using the imputed marginal cost series as an observable and find that the contribution of labor market frictions in explaining inflation dynamics is small.

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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 52 (2008)
Issue (Month): 8 (November)
Pages: 1464-1479

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Handle: RePEc:eee:eecrev:v:52:y:2008:i:8:p:1464-1479
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