The (dampened) wage-price spiral: Conflict, endogenous markup and inflation

Abstract

In this paper we develop a wage-setting/price-setting model in order to investigate the inflationary and distributive effects of markup changes and nominal wages growing above labour productivity. Firms set nominal prices targeting a real desired markup but only some of them are able to fully protect profits from expected inflation. Nominal wages are determined by expected inflation, autonomous wage pressures and the unemployment rate. Endogenously, the model determines real wages, real profits and inflation. Outcomes will differ with respect to the possibility of permanent changes in distribution and which inflation regime will prevail (‘accelerationist’ or steady-state inflation). Our results contrast with the traditional literature on conflicting-claims, in which real profits do not change during the inflationary process and the Non-Accelerating Inflation Rate of Unemployment (NAIRU) is the only stable equilibrium for the labour market. We show that conflicting-claims, in general, cause steady-state (rather than ‘accelerating’) inflation and the distributive neutrality case is a particular outcome (the model generates pro-cyclical real wages as the general case). A second novelty is modelling firms’ desired markup as the outcome of a bargaining between firms and workers, with the risk-free interest rate as the outside option for firms, such that the model is shown to be able to explain the so-called “Gibson Paradox”, also known as the “Price Puzzle” (i.e., the positive relation between prices and interest rate). Last, by treating the nominal profit margins as the control variable of the firms, the model does not rely on price rigidity to generate endogenous changes in income distribution.