Inflation and marginal cost: on the importance of their covariance

Sandeep Mazumder

Applied Economics Letters, 2011, vol. 18, issue 11, 1083-1089

Abstract: Many researchers have found that estimating the New Keynesian Phillips Curve (NKPC) using the output gap to proxy for real marginal cost tends to produce a counter-intuitive coefficient sign in the model, whereas using the labour income share produces the expected coefficient sign. This article investigates the potential cause of this puzzle: What causes these differing signs for the coefficient for real marginal cost? We find that this coefficient sign crucially depends on the covariance between inflation and marginal cost. Moreover, this covariance in turn critically depends on the cyclicality of the marginal cost proxy that is used.

Date: 2011
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DOI: 10.1080/13504851.2010.524608

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