WELFARE COSTS OF SHIFTING TREND INFLATION: STAGGERED WAGE AND PRICE CONTRACTS

We develop a New Keynesian model featuring staggered price and wage contracts to study welfare costs of exogenous variations in trend inflation. The analyses show that the consequences of constant positive trend inflation and shifting trend inflation are severe, especially when trend inflation is high. Among two channels, staggered wage contracts play a vital role in transmitting adverse impacts of constant and shifting trend inflation into the economy. Without the staggered wage channel, these costs are modest. We also conduct exercises to examine the sensitivity of welfare costs to a wide range of plausible parameters. The results show that if the price and wage friction are sufficiently large, the price and wage indexation level are sufficiently small, or there is upward biased trend inflation process, the welfare costs become larger.     

Does wage-inflation targeting complement foreign exchange intervention? An evaluation of a multi-target,two-instrument monetary policy framework

We assess the inclusion of wage inflation as an intermediate target of an emerging central bank using a dynamic stochastic general equilibrium model with sticky wages and prices calibrated for the South Korean economy. The model includes wage inflation as an additional target jointly with domestic price inflation and the output gap in a Taylor- type interest rate rule operating with a sterilized foreign exchange (FX) intervention rule. Our results show a complementary relationship between wage inflation targeting and price inflation targeting. That is, by supplementing price inflation targeting with wage inflation targeting, welfare improves for cases with and without sterilized FX intervention. When intervention is in place, wage inflation targeting has the added advantage of reducing the volatilities of nominal exchange rate and foreign exchange reserves thereby promoting a more sustainable conduct of FX intervention.     

Real wage rigidities and optimal monetary policy in a small open economy

The main objective of the study is to provide a theoretical analysis of optimal monetary policy in a small open economy where households set real wage in a staggered fashion. The introduction of real wage rigidities plays a important role to resolve main shortcomings of the standard new Keynesian small open economy model. The main findings regarding the issue of monetary policy design can be summarized as three fold. First, the optimal policy is to seek to minimize variance of domestic price inflation, real wage inflation, and the output gap if both domestic price and real wage are sticky. Second, controlling CPI inflation directly or indirectly induces relatively large volatility in output gap and other inflations. Therefore, both CPI inflation-based Taylor rule and nominal wage-inflation based Taylor rule are suboptimal. Last, a policy that responds to a real wage inflation is most desirable.     

The U.S. inflation process: Does nominal wage inflation cause price inflation,vice-versa,or neither?

Low unemployment has revived concerns about accelerated inflation. This paper examines the relationship between price and nominal wage inflation. It finds that it varies by business cycle. Prior to the great oil shock of 1973, price and nominal wage inflation were unconnected in a Granger-causal sense. In the 1970s, wage inflation caused price inflation. In the 1980s, the relationship reversed and price inflation caused nominal wage inflation. In the 1990s, the pattern has changed again, and there is some weak evidence of bidirectional causality between wages and PPI inflation. However, wages continue to have no impact on CPI inflation, which is widely viewed as one of the Fed's target variables. This suggests that wage inflation should be de-emphasized as a monetary policy information variable.     

The persistence of unemployment and the natural rate in Spain

The concept of the natural rate of unemployment is central to policy making because it indicates the capability of an economy to increase the growth of employment without increasing inflation. Since it is a nonobservable variable, an empirical counterpart must be estimated. The methodology used is based on a system of simultaneous equations that combines nominal developments (wage and price data) with the structural and institutional features (real data) of the economy. Hence, estimates of the natural rate and potential output which are consistent between themselves are obtained. They are both robust in terms of their relationship to actual wage and price inflation and comprehensive in terms of their underlying structural determinants.     

Testing price equations

How inflation and unemployment are related in both the short run and long run is perhaps the key question in macroeconomics. This paper tests various price equations using quarterly U.S. data from 1952 to the present. Issues treated are the following. (1) Estimating price and wage equations in which wages affect prices and vice versa versus estimating “reduced-form” price equations with no wage explanatory variables. (2) Estimating price equations in (log) level terms, first difference (i.e., inflation) terms, and second difference (i.e., change in inflation) terms. (3) The treatment of expectations. (4) The choice and functional form of the demand variable. (5) The choice of the cost-shock variable. The results suggest that the best specification is a price equation in level terms imbedded in a price-wage model, where the wage equation is also in level terms. The best cost-shock variable is the import price deflator, and the best demand variable is the unemployment rate. There is some evidence of a nonlinear effect of the unemployment rate on the price level at low values of the unemployment rate. Many of the results in this paper are contrary to common views in the literature, but the empirical support for them is strong.     

Inflation and Exchange Rate Regimes in Mexico

The paper presents a version of the exchange-rate-regime model of inflation. Quarterly data from Mexico from 1946 to 1995 are used to estimate and test a simultaneous-equation model for wage inflation, price inflation and industrial production, taking account of the Lucas critique and the statistical properties of the data. The main finding is that, after the fall of the fixed-exchange-rate regime in 1976, there was a Barro–Gordon type inflation bias owing to the inability of policymakers to commit to low inflation. There is no significant evidence of political business cycles in inflation.     

Wage inflation and labour conflicts in the Netherlands : An empirical investigation using the co-integration approach

The ‘wage space’, which is defined as the sum of price inflation and labour productivity growth, has played a major role as an indicator of allowable wage increases in the post-war wage negotiations in the Netherlands. This paper shows that: (a) wages and the wage space are co-integrated; (b) the deviation between wages and the wage space may act as an error correction term in the wage equation when both variables are identified as I(2); and (c) political consensus and the threat of labour conflicts (rather than actual strike activity) may be identified as the ‘mechanism’ behind this error correction in the wage equation.     

Observed expectations,news shocks,and the business cycle

This paper exploits information from the term structure of survey expectations to identify news shocks in a DSGE model with rational expectations.We estimate a structural business-cycle model with price and wage stickiness. We allow for both unanticipated and anticipated components (“news”) in each structural disturbance: neutral and investment-specific technology shocks, government spending shocks, risk premium, price and wage markup shocks, and monetary policy shocks.We show that the estimation of a standard DSGE model with realized data obfuscates the identification of news shocks and yields weakly or non-identified parameters pertaining to such shocks. The identification of news shocks greatly improves when we re-estimate the model using data on observed expectations regarding future output, consumption, investment, government spending, inflation, and interest rates - at horizons ranging from one-period to five-periods ahead.The news series thus obtained largely differ from their counterparts that are estimated using only data on realized variables. Moreover, the results suggest that the identified news shocks explain a sizable portion of aggregate fluctuations. News about investment-specific technology and risk premium shocks play the largest role, followed by news about labor supply (wage markup) and monetary policy.     

The dynamic effects of shocks to wages and prices in the United States and the Euro Area

This article investigates the dynamics of aggregate wages and prices in the United States (US) and the Euro Area (EA) with a special focus on persistence of real wages, wage and price inflation. The analysis is conducted within a structural vector error-correction model, where the structural shocks are identified using the long-run properties of the theoretical model, as well as the cointegrating properties of the estimated system. Overall, in the long run, wage and price inflation emerge as more persistent in the EA than in the US in the face of import price, unemployment, or permanent technology shocks. This finding is robust to the changes in the sample period and in the models’ specifications entertained in the article.     

The effects of indexation of wage contracts on macro-economic stability

The paper develops a simple analytical framework in which the shortrun affects of wage indexation on the dynamic stability of inflation can be analyzed. It consists of a unlonized labor market faced by a competitive demand. Without indexation, the wage contract is based upon the union's prediction of the price level during the period of the contract. With indexation, the same objective is achieved by contracting only once at some initial period, subject to the stipulation that the nominal wage is linked to the price level. The main result is that when the demand for money is sensitive to changes in the expected rate of inflation, nominal variables like prices and wages are more likely to yield an unstable dynamic response with wage indexation, thus endangering the monetary system.     

Inflation in the USA,UK and Australia:Some Comparisons*

USA, UK and Australian wage inflation experiences during the post-World-War-II period are examined principally within the framework of the long-run Phillips curve model. Attention is drawn to the sensitivity of wage rate changes to retail price level changes and to the possibility of a temporal change in this relationship. The analyses of these countries are compared so as to highlight similarities and differences.     

Relative wage concern: the missing piece in the contract multiplier?

Recent research has cast serious doubts on the explanatory power of staggered wage/price setting to account for both output and inflation persistence following money shocks. This paper extends a dynamic general equilibrium model with wage staggering by incorporating relative wage concern on the part of workers. In sharp contrast to previous analyses, in this model both output and inflation dynamics exhibit substantial persistence. Moreover, persistence results hold for a wide range of parameterisations. Our results suggest that relative wage concern may be the missing piece in the money shock persistence puzzle.     

From profit margins to income distribution: Joan Robinson's odyssey from marginal productivity theory

The point of departure for this paper is a 1941 Note on profit margins co-authored by Joan Robinson and Nicholas Kaldor that remained unpublished until 2000. Robinson's reviews of Henry Clay's The Problem of Industrial Relationships, Bresciani Turroni's The Economics of Inflation, and Roy Harrod's Towards a Dynamic Economics, along with her 1965 Cambridge Inaugural Lecture, may be interpreted as analogous documents that develop her critique of neoclassical wage theory and identify the money wage as the economy's ‘key’ price. These publications were critical steps toward the wage mark-up hypothesis and Post-Keynesian support of incomes policy to contain inflation. Robinson's Harrod review anticipated her later ideas about economic growth. With Kalecki's notion of ‘the degree of monopoly’ and her own concept of neo-mercantilism (from the Inaugural Lecture), these themes are nascent in the Robinson–Kaldor Note on profit margins.     

Some implications of the natural rate hypotheses

Changes in the anticipated and actual levels of inflation change the incentive to hold monetary and nonmonetary assets. We present a model with a production sector and markets for labor, capital, bonds, and money. The response of the model to changes in the anticipated inflation rate is derived. Restrictions implied by the various natural rate hypotheses are discussed. An asymmetry in the response of the economy to anticipated inflation and deflation makes the natural rate conditions more plausible for inflationary as opposed to deflationary equilibria. A new version of the liquidity trap is suggested by the analysis.     

New Keynesian Versus New Classical Theories of Aggregate Supply: Evidence from the Oecd Countries

Using annual and quarterly data for the OECD countries this paper tests four theories of aggregate supply, namely the sticky wage, the sticky price, the worker misperception and the producer misinformation models. The empirical estimates suggest that the short run aggregate supply curve is positively sloped as a result of price and wage stickiness. Furthermore, the slope of the aggregate supply curve is found to be a positive function of the rate of inflation which is consistent with the sticky price model.     

The Yugoslav inflation: Some competing hypotheses

Various hypotheses about wage and price inflation in Yugoslavia are presented and tested empirically with quarterly data from the 1962–1972 period. Both theoretical literature and empirical evidence on the behavior of the self-managed firm are used to derive different models of wage determination. The wage-equation results indicate that labor-market conditions, inflationary expectations; and labor-productivity variables are significant determinants of the rate of growth of wages. The price equations, based on a modified cost-markup model consistent with the practices of Yugoslav firms, identify labor costs and aggregate demand as significant determinants of the rate of growth of prices. University of California, Berkeley.     

WELFARE COST OF INFALTION IN A NEW KEYNESIAN MODEL

We study the welfare cost of inflation in a new Keynesian dynamic stochastic general equilibrium model. Nominal prices and wages are subjected to Taylor‐style adjustments in the benchmark model. We find that the welfare cost of inflation in a new Keynesian dynamic stochastic general equilibrium model is much higher than its counterpart in a real business cycle model. We also find that the welfare cost of inflation increases linearly with the inflation rate with the introduction of monopolistic competition but rises faster as the inflation rate increases with the introduction of nominal rigidity. Alternative price and wage setting schemes, such as Rotemberg and Calvo‐style adjustments would yield welfare costs of moderate inflation that are 2–10 times higher.     

COMPARATIVE ANALYSIS OF EXCHANGE RATE APPRECIATION AND AGGREGATE ECONOMIC ACTIVITY: THEORY AND EVIDENCE FROM MIDDLE EASTERN COUNTRIES

The paper examines the effects of exchange rate depreciation on real output and price in a sample of 11 developing countries in the Middle East. The theoretical model decomposes movements in the exchange rate into anticipated and unanticipated components. Unanticipated currency fluctuations determine aggregate demand through exports, imports, and the demand for domestic currency, and determine aggregate supply through the cost of imported intermediate goods. The evidence indicates that the supply channel attributed to anticipated exchange rate appreciation results in limited effects on output growth and price inflation. Consistent with theory's predictions, unanticipated appreciation of the exchange rate appears more significant with varying effects on output growth and price inflation across developing countries.     

Real wages,profit margins and inflation in Turkish manufacturing under post-liberalization

This article reports investigations into the behaviour of gross profit margins (mark-ups) in Turkish manufacturing industries for the post-1980 liberalization period in relation to price inflation, trade liberalization (openness) and real wage costs. Panel data econometrics over 29 subsectors of Turkish manufacturing are used over the period 1980–1996. Results suggest that profit margins are positively and significantly related both to price inflation and real wage costs. However, openness is found to have very little impact on profit margins.