Structural Inflation Models with Real Wage Rigidities: The Case of Canada

Real wage rigidities have recently been proposed as a way of building intrinsic persistence in inflation within the context of New Keynesian Phillips Curves. Using two recent illustrative structural models, we evaluate empirically the importance of real wage rigidities in the data and the extent to which such models provide useful information regarding price stickiness. Structural estimation and testing is carried out using Canadian data and identification-robust methods. Results based on one of the models are relatively uninformative. Our tests reveal important identification difficulties and considerable estimate uncertainty, as can be seen from the wide projections for the estimates. However, we obtain economically reasonable ranges for estimates of average frequency of price changes and some evidence for rigidity in real wages (as measured by a rigidity index) based on the other model we examine. In addition, our specification for the latter model yields significant [at usual levels] and correctly-signed reduced-form coefficient estimates, showing a trade-off between unemployment and inflation in the New Keynesian Phillips curve. From a methodological perspective, these results derive from our treatment of the productivity term as observable although with error, which seems to capture vital information and improve overall identification. From a substantive perspective, our findings suggest that wage-rigidity based New Keynesian Phillips Curves hold promise empirically and provide interesting research directions.