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Inflation and Unit Labor Cost


We study two decompositions of inflation, , motivated by a New Keynesian Pricing Equation. The first uses four components: lagged , expected future , real unit labor cost ( ), and a residual. The second uses two components: fundamental inflation (discounted expected future ) and a residual. We find large low-frequency differences between actual and fundamental inflation. From 1999-2011 fundamental inflation fell by more than 15 percentage points, while actual inflation changed little. We discuss this discrepancy in terms of the data (a large drop in labor's share of income) and through the lens of a canonical structural model (Smets-Wouters (2007)).

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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 44 (2012)
Issue (Month): (December)
Pages: 111-149

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Handle: RePEc:mcb:jmoncb:v:44:y:2012:i::p:111-149
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  1. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  2. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
  3. Carl E. Walsh, 2010. "Monetary Theory and Policy, Third Edition," MIT Press Books, The MIT Press, edition 3, volume 1, number 0262013770, June.
  4. Miles S. Kimball, 1995. "The Quantitative Analytics of the Basic Neomonetarist Model," NBER Working Papers 5046, National Bureau of Economic Research, Inc.
  5. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  6. 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.
  7. 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.
  8. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1997. "Sticky price and limited participation models of money: A comparison," European Economic Review, Elsevier, vol. 41(6), pages 1201-1249, June.
  9. 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.
  10. John Y. Campbell & Robert J. Shiller, 1986. "Cointegration and Tests of Present Value Models," NBER Working Papers 1885, National Bureau of Economic Research, Inc.
  11. Frank Smets & Rafael Wouters, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," American Economic Review, American Economic Association, vol. 97(3), pages 586-606, June.
  12. Argia M. Sbordone, 2001. "Prices and Unit Labor Costs: A New Test of Price Stickiness," Departmental Working Papers 199822, Rutgers University, Department of Economics.
  13. Sungbae An & Frank Schorfheide, 2007. "Bayesian Analysis of DSGE Models—Rejoinder," Econometric Reviews, Taylor & Francis Journals, vol. 26(2-4), pages 211-219.
  14. Eichenbaum, Martin & Fisher, Jonas D.M., 2007. "Estimating the frequency of price re-optimization in Calvo-style models," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 2032-2047, October.
  15. Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Working Paper Research 35, National Bank of Belgium.
  16. An, Sungbae & Schorfheide, Frank, 2005. "Bayesian Analysis of DSGE Models," CEPR Discussion Papers 5207, C.E.P.R. Discussion Papers.
  17. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
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