German and American wage and price dynamics: Differences and common themes

Abstract

The theoretical section of this paper develops a new nonstructural model of wage and price adjustment that integrates several concepts that have often been treated separately, including Phillips curve ‘level effects’, hysteresis ‘change effects’, the error-correction mechanism, and the role of changes in labor's share that act as a supply shock. The empirical analysis reaches two striking conclusions. First, during 1973–1990 coefficients in our German wage equations are remarkably similar to those in the U.S., with almost identical estimates of the Phillips curve slope, of the hysteresis effect, and of the NAIRU. The two countries also share similar inflation behavior, in that inflation depends more closely on the capacity utilization rate than on the unemployment rate. The big difference between the two countries is that there seems to be no feedback from wages to prices in Germany, and so high unemployment does not put downward pressure on the inflation rate. During the 1970s and 1980s in Germany there emerged a growing mismatch between the labor market and industrial capacity, so that the unemployment rate consistent with the mean (constant-inflation) utilization rate (‘MURU’) increased sharply, while in the U.S. the MURU was relatively stable.