Inflation and Unit Labor Cost

Robert G. King and Mark W. Watson

Journal of Money, Credit and Banking, 2012, vol. 44, issue s2, 111-149

Abstract: We study two decompositions of inflation, π, motivated by the standard New Keynesian pricing equation of Gali, Gertler, and Sbordone. The first uses four components: lagged π, expected future π, real unit labor cost (ψ), and a residual. The second uses two components: fundamental inflation (discounted expected future ψ) and a residual. We find large low‐frequency differences between actual and fundamental inflation. From 1999 to 2011 fundamental inflation fell by more than 15 percentage points, while actual inflation changed little. We discuss this discrepancy in terms of the data (a large drop in labor's share of income) and through the lens of a canonical structural model.

Date: 2012
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https://doi.org/10.1111/j.1538-4616.2012.00555.x

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Persistent link: https://EconPapers.repec.org/RePEc:wly:jmoncb:v:44:y:2012:i:s2:p:111-149

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