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Does the labor share of income drive inflation?

  • Jeremy Rudd
  • Karl Whelan

Woodford (2001) has presented evidence that the new-Keynesian Phillips curve fits the empirical behavior of inflation well when the labor 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 labor income share, in turn implying that central banks should raise interest rates in response to increases in the labor share. We show that the empirical evidence generally suggests that the labor share version of the new-Keynesian Phillips curve is a very poor model of price inflation. We conclude that there is little reason to view the labor income share as a good measure of the output gap, or as an appropriate variable for incorporation in a monetary policy rule.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2002-30.

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Date of creation: 2002
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Handle: RePEc:fip:fedgfe:2002-30
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  1. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  2. Sbordone, Argia, 1998. "Prices and Unit Labor Costs: A New Test of Price Stickiness," Seminar Papers 653, Stockholm University, Institute for International Economic Studies.
  3. Argia Sbordone, 2002. "An optimizing model of U.S. wage and price dynamics," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  4. Fuhrer, Jeff & Moore, George, 1995. "Inflation Persistence," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 127-59, February.
  5. 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.
  6. Jordi Galí & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
  7. Marvin Goodfriend & Robert G. King, 2001. "The case for price stability," Working Paper 01-02, Federal Reserve Bank of Richmond.
  8. 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.
  9. repec:ucn:oapubs:10197/249 is not listed on IDEAS
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