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Does labor's share drive inflation?

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  • Jeremy Rudd
  • Karl Whelan

Abstract

A number of researchers have recently argued that the new-Keynesian Phillips curve matches 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. The theoretical motivation for these results rests on the idea 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 this variable. 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.

Suggested Citation

  • Jeremy Rudd & Karl Whelan, 2005. "Does labor's share drive inflation?," Open Access publications 10197/243, School of Economics, University College Dublin.
  • Handle: RePEc:ucn:oapubs:10197/243
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    File URL: http://hdl.handle.net/10197/243
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    References listed on IDEAS

    as
    1. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
    2. Sbordone, Argia M., 2002. "Prices and unit labor costs: a new test of price stickiness," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 265-292, March.
    3. Galí, Jordi & Gertler, Mark, 1999. "Inflation Dynamics: A Structural Economic Analysis," CEPR Discussion Papers 2246, C.E.P.R. Discussion Papers.
    4. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
    5. Marvin Goodfriend & Robert G. King, 2001. "The Case for Price Stability," NBER Working Papers 8423, National Bureau of Economic Research, Inc.
    6. Jeff Fuhrer & George Moore, 1995. "Inflation Persistence," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 127-159.
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