Measuring the Interaction of Wage and Price Phillips Curves for the U.S. Economy

Abstract

This paper demonstrates that demand pressure, besides hybrid cost-pressure, matters both on the labor market and on the market for goods in the determination of wage and price inflation. We discuss theoretically and estimate for the USA wage and price Phillips curves exhibiting their own demand pressure measure in their respective market and weighted averages of perfectly foreseen short- and adaptively changed medium-run cost-pressure terms in addition. These curves are in their formal structure closely related to NK staggered wage and price dynamics, but differ radically from them in their implications. Our findings are that wages are more flexible than prices with respect to their demand pressure measure and that price determination gives much more weight to medium term inflation than does wage inflation. Supplemented by Okun's law, this implies a reduced form real wage dynamic that depends positively on economic activity, and thus an adverse type of real wage adjustment, if goods demand depends positively on real wages.