Downward Nominal Wage Rigidities Bend the Phillips Curve

We introduce a model of monetary policy with downward nominal wage rigidities and show that both the slope and curvature of the Phillips curve depend on the level of inflation and the extent of downward nominal wage rigidities. This is true for the both the long‐run and the short‐run Phillips curve. Comparing simulation results from the model with data on U.S. wage patterns, we show that downward nominal wage rigidities likely have played a role in shaping the dynamics of unemployment and wage growth during the last three recessions and subsequent recoveries.     

The (ir)relevance of real wage rigidity in the New Keynesian model with search frictions

We develop a New Keynesian model with search and matching frictions in the labor market. We show that the model generates counterfactual labor market dynamics. In particular, it fails to generate the negative correlation between vacancies and unemployment in the data, i.e., the Beveridge curve. Introducing real wage rigidity leads to a negative correlation, and increases the magnitude of labor market flows to more realistic values. However, inflation dynamics are only weakly affected by real wage rigidity. The reason is that labor market frictions give rise to long-run employment relationships. The measure of real marginal costs that is relevant for inflation in the Phillips curve contains a present value component that varies independently of the real wage.     

The Phillips curve under state-dependent pricing

We derive a Phillips curve equation from the dynamic stochastic general equilibrium (DSGE) model with state-dependent pricing developed by Dotsey et al. [1999. State-dependent pricing and the general equilibrium dynamics of money and output. Quarterly Journal of Economics 114, 655-690]. This state-dependent Phillips curve encompasses the new Keynesian Phillips curve (NKPC) based on Calvo-type price setting as a special case. We analyze the effect of the state-dependent terms (that is, the variations in the distributions of price vintages) on inflation persistence, and we examine whether the hybrid NKPC (that is, the NKPC extended by a lagged inflation term) can adequately describe inflation dynamics generated in a calibrated state-dependent pricing economy.     

Do expected future marginal costs drive inflation dynamics?

This article discusses a more general interpretation of the two-step minimum distance estimation procedure proposed in Sbordone (2002). The estimator is again applied to a version of the New Keynesian Phillips curve, where inflation dynamics are driven by the expected evolution of marginal costs. The article clarifies econometric issues, addresses concerns about uncertainty and model misspecification raised in recent studies, and assesses the robustness of previous results. While confirming the importance of forward-looking terms in accounting for inflation dynamics, it suggests how the methodology can be applied to extend the analysis of inflation to a multivariate setting.     

Supply‐Side Policies in the Depression: Evidence from France

The effects of supply‐side policies in depressed economies are controversial. We shed light on this debate using evidence from France in the 1930s. In 1936, France departed from the gold standard and implemented mandatory wage increases and hours restrictions. Deflation ended but output stagnated. We present time‐series and cross‐sectional evidence that these supply‐side policies, in particular the 40‐hour law, contributed to French stagflation. These results are inconsistent both with the standard one‐sector New Keynesian model and with a medium scale, multisector model calibrated to match our cross‐sectional estimates. We conclude that the New Keynesian model is a poor guide to the effects of supply‐side shocks in depressed economies.     

International Evidence on the New Keynesian Phillips Curve Using Aggregate and Disaggregate Data

We present a unique empirical analysis of the properties of the New Keynesian Phillips Curve (NKPC) using an international data set of aggregate and disaggregate sectoral inflation. Our results from panel time‐series estimation clearly indicate that sectoral heterogeneity has important consequences for aggregate inflation behavior. Heterogeneity helps to explain the overestimation of inflation persistence and underestimation of the role of marginal costs in empirical investigations of the NKPC that use aggregate data. We find that combining disaggregate information with heterogeneous‐consistent estimation techniques helps to reconcile, to a large extent, the NKPC with the data.     

Long‐Run Inflation and the Distorting Effects of Sticky Wages and Technical Change

We show that the Calvo price‐setting model is not necessarily inconsistent with evidence of a weak relation between positive trend inflation and price dispersion. We identify the interaction between sticky wages and technical change as factors disrupting the allocative role of the wage system under positive trend inflation. In turn, this interaction generates inefficient wage dispersion, as opposed to price dispersion, which fuels inflation costs. We conclude that it is too early to dismiss the New Keynesian model as a useful vehicle to assess the costs of inflation.     

New measures of the output gap based on the forward-looking new Keynesian Phillips curve

Forward-looking versions of the New Keynesian Phillips curve imply that the output gap, the deviation of the actual output from its natural level due to nominal rigidities, drives the dynamics of inflation relative to expected inflation. We exploit this to set up a bivariate unobserved component model for extracting new estimates of the output gap in the US. The gap estimates are large and persistent even after allowing for correlated trend and cycle shock. We then augment our model to use the information in the unemployment rate. The estimates confirm the presence of a large and persistent cyclical component.     

The Role of Real Wage Rigidity and Labor Market Frictions for Inflation Persistence

We analyze the transmission mechanism of wages to inflation within a New Keynesian business cycle model with wage rigidities and labor market frictions. Our main focus is on the channel of real wage rigidities on inflation persistence for which we find the specification of the wage bargaining process to be of crucial importance. Under the standard efficient Nash bargaining, the feedback of wage rigidities on inflation is ambiguous and depends on other labor market variables. However, under the alternative right‐to‐manage bargaining we find that more rigid wages translate directly into more persistent movements of aggregate inflation.     

Inflation dynamics with search frictions: A structural econometric analysis

The New Keynesian Phillips curve explains inflation dynamics as being driven by current and expected future real marginal costs. In competitive labor markets, the labor share can serve as a proxy for the latter. In this paper, we study the role of real marginal cost components implied by search frictions in the labor market. We construct a measure of real marginal costs by using newly available labor market data on worker finding rates. Over the business cycle, the measure is highly correlated with the labor share. Estimates of the Phillips curve using generalized method of moments reveal that the marginal cost measure remains significant, and that inflation dynamics are mainly driven by the forward-looking component. Bayesian estimation of the full New Keynesian model with search frictions helps us disentangle which shocks are driving the economy to generate the observed unit labor cost dynamics. We find that mark-up shocks are the dominant force in labor market fluctuations.     

Optimal Monetary Policy in a Model with Agency Costs

This paper integrates a fully explicit model of agency costs into an otherwise standard Dynamic New Keynesian model in a particularly transparent way. A principal result is the characterization of agency costs as endogenous markup shocks in an output‐gap version of the Phillips curve. The model's utility‐based welfare criterion is derived explicitly and includes a measure of credit market tightness that we interpret as a risk premium. The paper also fully characterizes optimal monetary policy and provides conditions under which zero inflation is the optimal policy. Finally, optimal policy can be expressed as an inflation targeting criterion that (depending upon parameter values) can be either forward or backward looking.     

Inventory Investment and the Empirical Phillips Curve

In this paper, we study the Calvo pricing models with finished goods inventory investment to demonstrate that the current inflation can be expressed as a function of the marginal cost of sales, not the marginal production cost, and expected future inflation. Under the assumption that the true aggregate marginal costs are not observable in actual data, we make use of equilibrium conditions for aggregate finished goods inventories to measure the time series of marginal costs, thereby leading to the construction of inflation series on the basis of the Phillips curve. Our results indicate the possibility of a successful fit of the empirical New Keynesian Phillips curve without relying on unit labor cost—a conventional measure of marginal production cost in the literature.     

Downward Nominal Wage Rigidity and Inflation Dynamics during and after the Great Recession

In this paper, I develop a New Keynesian model that embeds heterogeneous workers with asymmetric wage adjustment costs to address two inflation puzzles: missing deflation during the Great Recession and the subsequent missing inflation. When the wage adjustment costs are estimated according to U.S. microwage data, downward nominal wage rigidity emerges, which flattens the observed price Phillips curve during and after recessions. Endogenous evolution of the cross-sectional wage distribution generates nonlinear dynamics including the sign, size, and state dependence. These nonlinearities enable the model to address the inflation puzzles as well as matching microevidence on wage adjustments.     

How Do Nominal and Real Rigidities Interact? A Tale of the Second Best

This paper analyzes the importance of real wage rigidities, in particular through their interaction with price stickiness, in a New Keynesian model. Real wage rigidities result from a combination of staggered wage setting and partial indexation of nonreset wages to past inflation. Blanchard and Galí (2007) show real rigidities to introduce a trade‐off between stabilizing inflation and the welfare‐relevant output gap. The present paper complements their findings by showing that the welfare costs of real rigidities can be substantial compared to nominal frictions. In a typical “tale of the second best,” we also show that in the presence of real wage rigidities, higher price stickiness can be welfare enhancing.     

Robustness of the estimates of the hybrid New Keynesian Phillips curve

Galí and Gertler [1999. Inflation dynamics: a structural econometric approach. Journal of Monetary Eonomics 44(2), 195-222] developed a hybrid variant of the New Keynesian Phillips curve that relates inflation to real marginal cost, expected future inflation and lagged inflation. GMM estimates of the model suggest that forward-looking behavior is dominant: the coefficient on expected future inflation substantially exceeds the coefficient on lagged inflation. While the latter differs significantly from zero, it is quantitatively modest. Several authors have suggested that our results are the product of specification bias or suspect estimation methods. Here we show that these claims are incorrect, and that our results are robust to a variety of estimation procedures, including GMM estimation of the closed form, and nonlinear instrumental variables. Also, as we discuss, many others have obtained very similar results to ours using a systems approach, including FIML techniques. Hence, the conclusions of GG and others regarding the importance of forward-looking behavior remain robust.     

New tests of the new-Keynesian Phillips curve

Lagged dependent variables typically play an important role in empirical models of inflation. Do these lags reflect backward-looking inflation expectations, or do they proxy for rational forward-looking expectations, as in the new-Keynesian Phillips curve? Galí and Gertler [1999. Inflation dynamics: a structural econometric analysis. Journal of Monetary Economics 44, 195-222] attempt to answer this question using GMM to estimate specifications incorporating both lagged and future inflation. They report small coefficients on lagged inflation and conclude that the new-Keynesian model provides a good first approximation to inflation dynamics. We show that these tests have low power against alternative backward-looking specifications, and demonstrate that their results are also consistent with a backward-looking Phillips curve. Using an alternative approach, we find that the new-Keynesian pricing model cannot explain the importance of lagged inflation in standard inflation regressions, and find that forward-looking terms play a very limited role in explaining inflation dynamics.     

A Phillips Curve with Anchored Expectations and Short‐Term Unemployment

This paper examines the behavior of U.S. core inflation, as measured by the weighted median of industry price changes. We find that core inflation since 1985 is well‐explained by an expectations‐augmented Phillips curve in which expected inflation is measured with professional forecasts and labor‐market slack is captured by the short‐term unemployment rate. We also find that expected inflation was backward‐looking until the late 1990s, but then became strongly anchored at the Federal Reserve's target. This shift in expectations changed the relationship between inflation and unemployment from an accelerationist Phillips curve to a level‐level Phillips curve. Our specification explains why high unemployment during the Great Recession did not reduce inflation greatly: partly because inflation expectations were anchored, and partly because short‐term unemployment rose less sharply than total unemployment.     

What Makes the Output–Inflation Trade‐Off Change? The Absence of Accelerating Deflation in Japan

It is standard to model the output–inflation trade-off as a linear relationship with a time-invariant slope. We assess empirical evidence for two sets of theories that allow for endogenous variation in the slope of the short-run Phillips curve. At an empirical level, we examine why large negative output gaps in Japan in the late 1990s did not lead to accelerating deflation but instead coincided with stable, albeit moderately negative inflation. Our results suggest that this episode is most convincingly interpreted as reflecting a gradual flattening of the Phillips curve. We find that this flattening is best explained by models with endogenous price durations. These models imply that in any economy where trend inflation is substantially lower (or substantially higher) today than in past decades, time variation in the slope of the Phillips curve has become too important to ignore.     

The labour market in an equilibrium business cycle model

This paper extends the basic, multimarket model of Lucas (1973), to explicitly consider the labour market. It builds on an important distinction between the product wage, entering the decision function of firms, and the real wage, entering the decision function of workers. Because of the unobservability of the price level workers make forecasting errors in trying to calculate their real wage, despite having rational expectations. This gives rise to a Phillips curve. The major new result of the paper is the demonstration that wages are less variable than prices, which offers an equilibrium interpretation of wage stickiness.     

Non-Atomistic Wage Setters and Monetary Policy in a New Keynesian Framework

This paper extends an otherwise standard New Keynesian (NK) model to allow for the presence of large wage setters. Building on monetary models from an earlier generation, I contribute to the NK literature by adding some new insight. It is shown that once the presence of large wage setters is taken into account, the degree of wage setting centralization and the aggressiveness of the central bank in stabilizing inflation jointly affect steady state employment. Because of this interaction, the benefits associated with inflation stabilization increase in the centralization of the wage bargaining process.