THE ECONOMETRICS OF MACROECONOMIC MODELLING
Comparison with the wage Phillips curve NAIRU
In the case of no equilibrium correction in nominal wage-setting, 9w = 0, equation (6.1) simplifies to
Awt = Cw + фwpApt + фwqAqt - yut-1 + £w, t, (6.42)
which is consistent with the short-run Phillips curve in equation (4.1) of Chapter 4. From the stability analysis of Section 6.3, 9w =0 implies A = 0 and к = 0 in (6.9) and (6.12), and the solution of the system is qualitatively identical to the ‘no wedge’ case: the real wage is stable around the productivity trend, whereas the real exchange rate is unstable because of the unit root. Thus there is a paradox in the sense that despite the open economy Phillips curve in (6.42), there is no implied equilibrium rate of unemployment (uphl1) of the form found in equation (4.10) in Chapter 4. However, it is clear that the Phillips curve system involves an important extra assumption: foreign prices were assumed to be taken as given by domestic producers, which in the present model translates into 9q = фqw = 0. Thus, restricting both wage - and price-setting by imposing
9w 9 q фqw °?
is seen to imply two unit roots, and the system is now cast in terms of the two difference variables Awq, t and Apiq, t. Consequently, neither the real wage level nor the real exchange rate are dynamically stable (even subtracting the productivity trend). Heuristically, in order to re-establish a stable steady state for the real wage, the assumption of a separate stationary model for ut must be replaced by something like equation (4.2) in Chapter 4, that is, a separate equation for the rate of unemployment.[44]
