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Does the Labour Share of Income Drive Inflation?

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  • Rudd, Jeremy

    (Federal Reserve Board)

  • Whelan, Karl

    (Central Bank and Financial Services Authority of Ireland)

Abstract

Recent years have seen a proliferation in research aimed at assessing monetary policy rules using macroeconomic models built from explicit micro-foundations. In many versions of these models, pricing behaviour is described by a ``new-Keynesian Phillips curve,'' which relates inflation to expected future inflation and a driving variable related to production costs. Woodford (2001) has presented evidence that the new-Keynesian Phillips curve fits the empirical behaviour of U.S. inflation well when the labour income share is used as a driving variable, but fits poorly when deterministically detrended output is used. He concludes that the output gap---the deviation between actual and potential output---is better captured by the labour income share, in turn implying that central banks should raise interest rates in response to increases in the labour share. We show that the empirical evidence generally suggests that the labour share version of the new-Keynesian Phillips curve is a very poor model of U.S. price inflation. We conclude that there is little reason to view the labour income share as a good measure of the output gap, or as an appropriate variable for incorporation in a monetary policy rule.

Suggested Citation

  • Rudd, Jeremy & Whelan, Karl, 2002. "Does the Labour Share of Income Drive Inflation?," Research Technical Papers 2/RT/02, Central Bank of Ireland.
  • Handle: RePEc:cbi:wpaper:2/rt/02
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    References listed on IDEAS

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    1. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
    2. Rudd, Jeremy & Whelan, Karl, 2005. "New tests of the new-Keynesian Phillips curve," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1167-1181, September.
    3. Jeff Fuhrer & George Moore, 1995. "Inflation Persistence," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 127-159.
    4. Fuhrer, Jeffrey C., 2010. "Inflation Persistence," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 9, pages 423-486, Elsevier.
    5. Argia M. Sbordone, 2002. "An optimizing model of U.S. wage and price dynamics," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
    6. Sbordone, Argia M., 2002. "Prices and unit labor costs: a new test of price stickiness," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 265-292, March.
    7. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
    8. Rotemberg, Julio J. & Woodford, Michael, 1999. "The cyclical behavior of prices and costs," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 16, pages 1051-1135, Elsevier.
    9. Marvin Goodfriend & Robert G. King, 2001. "The Case for Price Stability," NBER Working Papers 8423, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Gerard O'Reilly & Karl Whelan, 2005. "Has Euro-Area Inflation Persistence Changed Over Time?," The Review of Economics and Statistics, MIT Press, vol. 87(4), pages 709-720, November.
    2. Paloviita, Maritta, 2008. "Dynamics of inflation expectations in the euro area," Scientific Monographs, Bank of Finland, number 40/2008.
    3. Jeremy Rudd & Karl Whelan, 2006. "Can Rational Expectations Sticky-Price Models Explain Inflation Dynamics?," American Economic Review, American Economic Association, vol. 96(1), pages 303-320, March.
    4. Peter Tillmann, 2009. "The New Keynesian Phillips curve in Europe: does it fit or does it fail?," Empirical Economics, Springer, vol. 37(3), pages 463-473, December.
    5. Wallis, Kenneth F., 2004. "Comparing empirical models of the euro economy," Economic Modelling, Elsevier, vol. 21(5), pages 735-758, September.
    6. William Baeza L. & Pablo García., 2003. "Medidas Alternativas de Brechas en Modelos de Inflación," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 6(2), pages 77-94, August.
    7. Coenen, Gunter, 2007. "Inflation persistence and robust monetary policy design," Journal of Economic Dynamics and Control, Elsevier, vol. 31(1), pages 111-140, January.
    8. Kuttner, Ken & Robinson, Tim, 2010. "Understanding the flattening Phillips curve," The North American Journal of Economics and Finance, Elsevier, vol. 21(2), pages 110-125, August.
    9. Nuno Alves, 2004. "A Flexible View on Prices," Working Papers w200406, Banco de Portugal, Economics and Research Department.
    10. Holmberg, Karolina, 2006. "Derivation and Estimation of a New Keynesian Phillips Curve in a Small Open Economy," Working Paper Series 197, Sveriges Riksbank (Central Bank of Sweden).
    11. Paloviita, Maritta, 2005. "The role of expectations in euro area inflation dynamics," Scientific Monographs, Bank of Finland, number 2005_032.

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