Category THE ECONOMETRICS OF MACROECONOMIC MODELLING

Nominal rigidity despite dynamic homogeneity

At first sight, one might suspect that the result that uss is undetermined by the wage – and price-setting equations has to do with dynamic inhomogeneity, or ‘monetary illusion’. For example, this is the case for the Phillips curve model where the steady-state rate of unemployment corresponds to the natural rate whenever the long-run Phillips curve is vertical, which in turn requires that dynamic homogeneity is fulfilled. Matters are different in the model in this section, though. As explained above, the property of dynamic homogeneity requires that we impose фqw + фqi = 1 in the equation representing price form­ation, and фwq + ф^ = 1 in the dynamic wage curve. It is seen directly from (6.18) that the model is asymptotically stable even when made subject to these two restrictions...

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The Phillips curve

The Phillips curve ranges as the dominant approach to wage and price modelling in macroeconomics. In the United States, in particular, it retains its role as the operational framework for both inflation forecast­ing and for estimating the NAIR U. In this chapter, we will show that the Phillips curve is consistent with cointegration between prices, wages, and productivity, and a stationary rate of unemployment, and hence there is common ground between the Phillips curve and the Norwegian model of inflation of the previous chapter.

3.1 Introduction

The Norwegian model of inflation and the Phillips curve are rooted in the same epoch of macroeconomics...

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. Summary of time varying NAIRUs in the Nordic countries

In sum, for all three countries, we obtain stable empirical wage equations over the period 1964-94 (Denmark 1968-94). Nor do we detect changes in explana­tory variables in the wage-setting that can explain the rise in unemployment (as indicated by absence of an increasing trend in the AWSU indicator in Figure 6.4). The instability of the NAWRU estimate appears to be an arte­fact of a mis-specified underlying wage equation, and is not due to instability in the wage-setting itself...

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Wage bargaining and monopolistic competition

There is a number of specialised models of ‘non-competitive’ wage-setting; see, for example, Layard et al. (1991: ch. 7). Our aim in this section is to rep­resent the common features of these approaches in a theoretical model of wage bargaining and monopolistic competition, building on Rpdseth (2000: ch. 5.9) and Nymoen and Rpdseth (2003). We start with the assumption of a large number of firms, each facing downward-sloping demand functions. The firms are price setters and equate marginal revenue to marginal costs. With labour being the only variable factor of production (and constant returns to scale) we obtain the following price-setting relationship:

EIqY Wi
EIqY – 1 Ai ’

where Ai = Yi/Ni is average labour productivity, Yi is output, and Ni is labour input...

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Identifying partial structure in submodels

Model builders often face demands from model users that are incompatible with a 3-5 equations closed form model. Hence, modellers often find themselves dealing with submodels for the different sectors of the economy. Thus it is often useful to think in terms of a simplification of the joint distribution of all observable variables in the model through sequential factorisation, conditioning, and marginalisations.

1.3.1 The theory of reduction

Consider the joint distribution of xt = (x1t, x2t, ■ ■ ■, xnt)’, t = 1,…,T, and let xT = {xt}f=1. Sequential factorisation means that we factorise the joint density function Dx(xT | x0,Ax) into

T

Dx(xT 1 x0; Ax) Dx(x1 1 x0; Ax)l Dx(xt 1 xt—1> x0; Ax), (2.1)

t=2

which is what Spanos (1989) named the Haavelmo distribution...

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An important unstable solution: the ‘no wedge’ case

Real-wage resistance is an inherent aspect of the stable solution, as 6wu = 0 is one of the conditions for the stability of the wage-price system, cf. equation (6.15). However, as we have discussed earlier, the existence or otherwise of wedge effects remains unsettled, both theoretically and empirically, and it is of interest to investigate the behaviour of the system in the absence of real wage resistance, that is, 6wш = 0 due to ш = 0.

Inspection of (6.9) and (6.12) shows that in this case, the system partitions into a stable real wage equation

Wq, t = $t + £Apit + KWq, t-1 – nut-1, (6.28)

and an unstable equation for the real exchange rate

Apiq, t = – dt + eApit – kwq, t-1 + nut-1. (6.29)

Thus, in the same way as in the stable case of ш > 0, the real wage follows a stationary autoregr...

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