This paper provides further evidence of the fit of the new Keynesian Phillips curve for Japan over the period 1972-2003. It is motivated by the sense that Japan's degree of price rigidity found in Sanchez (2005) is implausibly severe and maybe unduly affected by assumption that real marginal cost is constant. It also tests whether the estimated parameters are time invariant, using structural break techniques developed in Rossi (2004) and Andrews (1993).
Second, this paper considers the impact of labor market frictions on the dynamic evolution of real marginal cost, which includes estimating the cost to the household of supplying additional labor. This parameter relates the marginal rate of substitution between consumption and labor to real wages and is analogous to the price markup over marginal cost used by the monopolistically competitive firm. Gal´?, Gertler and Lopez Salido (2001) and Fuhrer and Moore (1995) point out that labor market frictions providea additional source of inflation inertia not captured by the general new Keynesian Phillips curve, which has borne out in their studies.
Excluding the tests for structural breaks, which are thought unique to Sanchez (2005) and this work, my approach uses methodology found in Gal´?, et al (2001). They show that a simple alteration in the firm's production function, which determines the measure of real marginal cost, yields a more credible degree of rigidity for the U.S. and the Euro area.
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Inflation Dynamics in Japan: The Calvo Model and Wage Rigidity
