This paper is an attempt to model the joint behavior of prices and wages in a way consistent with intertemporal optimization and rational expectations. Its ultimate goal is to construct a Phillips curve specification that is consistent both with U.S. data and with optimizing behavior, to respond to the well known 0Lucas critique.
The Phillips curve relationship has undergone a fruitful re exploration in recent years. The effort has been devoted to explain the relation between nominal and real variables in rigorously specified general equilibrium, optimizing models. For example, the so called New Keynesian1 Phillips Curve (NKPC), which describes current inflation as a function of expected future inflation and a measure of output gap, is derived in the context of a general equilibrium, optimizing model, that allows some form of nominal rigidities, either by assuming staggered price setting (for example, in the style of Calvo (1983) model), or by assuming staggered wage setting, or both (for ex. Erceg et al. 1999).
Models with nominal rigidities have been explored mostly in the context of monetary policy analysis. Providing a channel for real effects of monetary disturbances, staggered wage and price settings are in fact a suitable framework to investigate issues such as the optimality of alternative monetary policies.
However, the standard NKPC model predicts counter factual comovement of output and inflation, unless there are large cyclical variations in potential output. For this reason, there have been some attempts to dismiss altogether the particular model of price setting that lies at the heart of the model.
Some recent studies, in particular, have questioned the importance of the forward looking component in pricing behavior, by focusing on the empirical failure of the inflation output equation that it implies. For example, Fuhrers (1997) empirical results point to a negligible role of future inflation in an estimated inflation output relationship, specified in a way that is intended to nest the New Keynesian Phillips Curve specification, the more complex variant proposed by Fuhrer and Moore (1995), and purely backward looking Phillips Curve specifications. Roberts (1997, 1998) argues instead that the New Keynesian Phillips Curve fits reasonably well when survey measures are used to approximate inflation expectations, but that it does not fit well under the hypothesis of rational expectations. He thus proposes a model with an important backward looking component in inflation expectations, which amounts to weakening the weight put on the forward looking terms in his aggregate supply relation.
Some other recent work has shown, however, that, unlike tests of the standard NKPC model, tests of the pricing equation alone, derived from a staggering price model, seem to fit inflation data quite well, providing empirical support for the hypothesis of nominal price rigidity, and for the importance of forward looking determinants of price setting behavior.In particular, Sbordone (1998) shows that, taking as given the evolution of unit labor costs, the dynamic of inflation predicted by sticky price models tracks actual data very closely, and imply a degree of price stickiness very much in line with that found through survey evidence.
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