THE ECONOMETRICS OF MACROECONOMIC MODELLING
Wage-price dynamics
This chapter discusses the modelling of the wage-price subsystem of the economy. We show that under relatively mild assumptions about price - and wage-setting behaviour, there exists a conditional steady state (for inflation and real wages) for any given long-run mean of the rate of unemployment. The view that asymptotic stability of inflation ‘requires’ that the rate of unemployment simultaneously converges to a NAIR U (which only depends on the properties of the wage and price equations) will be refuted both logically and empirically.
The open economy Phillips curve and the Incomplete Competition Model (ICM) appear to be positioned at opposite ends of a scale, with a simple dynamic model at the one end, and an economically more advanced but essentially static system at the other. In this section, we present a model of wage and price dynamics that contains the Phillips curve and the wage curve as special cases, building on the analyses in Kolsrud and Nymoen (1998) and Bardsen and Nymoen (2003).
Section 6.2 presents the basic set of equations, and defines the concepts of static and dynamic homogeneity and their relationships to nominal rigidity and absence of neutrality to nominal shocks. Section 6.3 defines the asymptotically stable solution of the system, and Section 6.4 discusses some important economic implications of the conditional wage-price model as well as special cases that are of substantive interest (e. g. the no wedge case, and a small open economy interpretation, akin to the Norwegian model of inflation). The comparison with the ICM is drawn in Section 6.5, while Section 6.6 covers the Phillips curve case. Section 6.7 then gives an overview of the existing
evidence in support of the restrictions that defines the two natural rate models. Since we find that the evidence of the respective NAIRU restrictions are at best flimsy, we expect that endeavours to estimate a time varying NAIRU run the danger of misrepresenting time varying coefficients of, for example, wage equations as changes in structural features of the economy, and Section 6.8 substantiates that claim for the four main Nordic countries.
In brief, the natural rate thesis that stability of inflation is tantamount to having the rate of unemployment converging to a natural rate, is refuted both theoretically and empirically in this chapter. Section 6.9 therefore sketches a model of inflation and unemployment dynamics that is consistent with the evidence and presents estimates of the system for the Norwegian data set that is used throughout.
