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Understanding the dynamics of labor shares and inflation

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  • Karl Whelan
  • Martina Lawless

Abstract

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.

Suggested Citation

  • Karl Whelan & Martina Lawless, 2007. "Understanding the dynamics of labor shares and inflation," Open Access publications 10197/220, School of Economics, University College Dublin.
    • Handle: RePEc:ucn:oapubs:10197/220
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    File URL: http://hdl.handle.net/10197/220
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    More about this item

    Keywords

    Labour Share; Phillips Curve; Sectoral Data; Labor market--Europe; Inflation (Finance)--Mathematical models;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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