U.S. wage and price dynamics: a limited information approach

Abstract: This paper analyzes the dynamics of prices and wages using a limited information approach to estimation. I estimate a two-equation model for the determination of prices and wages derived from an optimization-based dynamic model in which both goods and labor markets are monopolistically competitive; prices and wages can be reoptimized only at random intervals; and, when prices and wages are not reoptimized, they can be partially adjusted to previous-period aggregate inflation. The estimation procedure is a two-step minimum distance estimation that exploits the restrictions imposed by the model on a time-series representation of the data. In the first step, I estimate an unrestricted autoregressive representation of the variables of interest. In the second, I express the model solution as a constrained autoregressive representation of the data and define the distance between unconstrained and constrained representations as a function of the structural parameters that characterize the joint dynamics of inflation and labor share. This function summarizes the cross-equation restrictions between the model and the time-series representations of the data. I then estimate the parameters of interest by minimizing a quadratic function of that distance. I find that the estimated dynamics of prices and wages track actual dynamics quite well and that the estimated parameters are consistent with the observed length of nominal contracts.

Keywords: wage and price dynamics; nominal rigidities; minimum distance estimation;

JEL Classification: C32; C52; E32;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2006-08-01

Number: 256

Pages: 35 pages

Note: For a published version of this report, see Argia M. Sbordone, "U.S. Wage and Price Dynamics: A Limited Information Approach," International Journal of Central Banking 2, no. 3 (September 2006): 155-91.