What goes down must come up: understanding time-variation in the NAIRU
The behavior of inflation during the 1990s is consistent with the predictions of a model that assumes a constant long-run NAIRU and a constant long-run markup of output prices over unit labor costs. Within this framework, inflation fell during the late 1990s - despite low unemployment - chiefly because an unusually high markup allowed firms to increase wages without raising prices. As the markup returns to normal, the recent unusually favorable unemployment -inflation trade-off can be expected to deteriorate. More generally, movements in the markup induce persistent but ultimately temporary variation in the NAIRU.
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