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Understanding the Dynamics of Labour Shares and Inflation

  • Lawless, Martina

    (Central Bank and Financial Services Authority of Ireland)

  • Whelan, Karl

    (University College Dublin)

Calvo-style models of nominal rigidities currently provide the dominant paradigm for understanding the linkages between wage and price dynamics. Recent empirical implementations stress the idea that these models link inflation to the behavior of the labour share of income. Galí, Gertler, and Lopez-Salido (2001) argue that the model explains the combination of declining inflation and labour shares in Euro area. In this paper, we show that with realistic parameters, the canonical Calvo-style model cannot explain this outcome. In addition, we show that the model fails very badly in sectoral data. We examine the elements underlying the decline in the labour share in Europe, and conclude that the key factors are related to technological and labour market developments not accounted for in the standard New-Keynesian framework.

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Paper provided by Central Bank of Ireland in its series Research Technical Papers with number 4/RT/07.

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Length: 39 pages
Date of creation: May 2007
Date of revision:
Handle: RePEc:cbi:wpaper:4/rt/07
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