Working Paper: NBER ID: w9174
Authors: John C. Driscoll; Steinar Holden
Abstract: Most wage-contracting models with rational expectations fail to replicate the persistence in inflation observed in the data. We argue that coordination problems and multiple equilibria are the keys to explaining inflation persistence. We develop a wage-contracting model in which workers are concerned about being treated fairly. This model generates a continuum of equilibria (consistent with a range for the rate of unemployment), where workers want to match the wage set by other workers. If workers' expectations are based on the past behavior of wage growth, these beliefs will be self-fulfilling and thus rational. Based on quarterly U.S. data over the period 1955-2000, we find evidence that inflation is more persistent between unemployment rates of 4.7 and 6.5 percent, than outside these bounds, as predicted by our model.
Keywords: inflation persistence; wage contracting; coordination problems; fair treatment
JEL Codes: E31; E3; E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Workers' Fair Treatment (J83) | Wage Setting (J31) |
| Wage Setting (J31) | Inflation Persistence (E31) |
| Coordination Problems (E61) | Inflation Persistence (E31) |
| Unemployment Rates (4.7%-6.5%) (J64) | Inflation Persistence (E31) |
| Inflation Persistence (E31) | Unemployment Rates (J64) |
| Past Behavior of Price Setters (D43) | Current Expectations (D84) |
| Current Expectations (D84) | Inflation Persistence (E31) |