When Inflation Takes Hold: Labor-Market Pressure and Price Transmission

This paper develops and estimates a state-dependent Phillips curve in which labor-market pressure and price adjustment jointly determine when an inflationary disturbance becomes aggregate inflation. Tight labor markets select a wage branch that raises marginal-cost pressure, while the level and age profile of price adjustment determine how rapidly that pressure reaches prices and how long its effects survive. This interaction generates an inflation impact-persistence frontier. The pricing state with the strongest immediate pass-through need not be the state with the longest-lived response. Estimated on U.S. quarterly data, the model locates postwar inflation surges in a high-pass-through pricing environment and finds inflation most vulnerable when that environment coincides with strong labor-market pressure. Bayesian evidence favors the joint state structure over specifications that suppress either its labor-pressure margin or its pricing-state margin.