Keywords: Inflation interia, estimated DGE models.
Abstract: This paper reexamines wage and price dynamics in response to permanent shocks to
productivity. We estimate a micro-founded dynamic general equilibrium (DGE) model
of the U.S. economy with sticky wages and sticky prices using impulse responses to
technology and monetary policy shocks. We utilize a flexible specification for wage-
and price-setting that allows for the sluggish adjustment of both the levels of these
variables-as in standard contracting models-as well as intrinsic inertia in wage and
price inflation. On the price front, we find that in our VAR inflation jumps in response
to an identified permanent technology shock, implying that, on average, prices adjust
quickly and that there is little evidence for any intrinsic inflation inertia like that
commonly found in models used for monetary policy evaluation. On the wage front, we
find evidence for significant inertia in wages and some intrinsic inertia in nominal wage
inflation. Our results provide support for the standard sticky-price specification of the
New Keynesian model; however, the evidence on the high degree of wage inertia presents
a challenge for standard models of wage setting.
Full paper (273 KB PDF)
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Last update: January 8, 2004