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Essays on Inflation and Wage Dynamics: Theory and Evidence

  • Author(s): Kim, Insu
  • Advisor(s): Chauvet, Marcelle
  • et al.

This dissertation proposes a new Phillips curve that is able to endogenously generate inflation persistence in a profit-maximizing framework featuring sticky prices, in response to the critique to ad-hoc approaches directly incorporating a lagged inflation term into the Phillips curve by assuming that a fraction of firms reset their prices by automatic indexation to past period's inflation rate. In order to generate a lagged inflation term as a source of inflation persistence, I assume that although firms change their prices at discrete time intervals, they can not completely adjust prices due convex costs of changing prices. Hence, this dissertation introduces dual price stickiness with respect to the frequency and size of price adjustment. In addition to the dual price stickiness, this dissertation investigates the potential presence of dual wage stickiness: with respect to both the frequency as well as the size of wage adjustments. In particular, I derive a model of wage inflation dynamics assuming that although workers adjust wage contracts at discrete time intervals, they are limited in their abilities to adjust wages as much as they might desire.

The dual price (wage) stickiness model nests the baseline model, based on Calvo-type price (wage) stickiness, as a particular case. Empirical results favor the dual price (wage) stickiness model over the baseline model that assumes only one type of stickiness in several dimensions. In particular, it outperforms the baseline model in the ability to explain the observed "reverse dynamic" cross-correlation between price (wage) inflation and real output - which the baseline model fails to capture.

This dissertation also proposes an alternative new Keynesian modeling approach to evaluate the relative contribution of inflation expectations and inertia to inflation dynamics. Particular attention is given to avoid potential spurious regression analysis. My findings indicate that while the rising inflation in the 1970s is likely to be connected with changes in inflation expectations, the positive inflation trend in the 1960s is related to the role of a lagged inflation term in the Phillips curve. The results also provide evidence that the role of inflation expectations differs substantially before and after 1980. In particular, the coefficient associated with inflation expectations from the early 1980s to the end of the sample is half the values prevailing in the late 1960s and the 1970s. Finally, the findings indicate that there is little evidence supporting a rational, model-consistent inflation expectation.

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