Understanding the dynamics of labor shares and inflation

• Published in: Journal of macroeconomics Vol. 33; no. 2; pp. 121 - 136
• Main Authors: Lawless, Martina, Whelan, Karl T.
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier Inc 01-06-2011; Elsevier; Elsevier Science Ltd
• Series: Journal of Macroeconomics
• Subjects: Coefficients; Economic models; Estimation; Europe; Inflation; Inflation Labor shares; Labor economics; Labor shares; Labour; Modelling; National income; Price models; Studies; Wage rigidity; Europe; E25; E31; Inflation; Labor shares
• ISSN: 0164-0704; 1873-152X
• DOI: 10.1016/j.jmacro.2010.11.002

Calvo-style models of nominal rigidities currently provide the dominant paradigm for understanding the linkages between wage and price dynamics. Recent empirical implementations stress the idea that these models link inflation to the behavior of the labor share of income.
Gaı´ et al. (2001) argue that the model explains the combination of declining inflation and labor shares in Euro area. In this paper, we show that with realistic parameters, the canonical Calvo-style model cannot explain the joint behavior of inflation and the labor share in Europe. In addition, we show that the model fails very badly in sectoral data with consistently negative estimated coefficients on the labor share in a number of different inflation specifications. Indeed, the use of a traditional output gap measure proved more successful in terms of a positive relationship with inflation.