Understanding the Dynamics of Labor Shares and Inflation

45 Pages Posted: 26 Jul 2007

See all articles by Martina Lawless

Martina Lawless

Central Bank and Financial Services Authority of Ireland - Economic Analysis and Research Department

Karl Whelan

Central Bank and Financial Services Authority of Ireland - Economic Analysis and Research Department

Date Written: July 2007

Abstract

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. GalĂ­, Gertler, and Lopez-Salido (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 this outcome. In addition, we show that the model fails very badly in sectoral data. We examine the elements underlying the decline in the labor share in Europe, and conclude that the key factors are related to technological and labor market developments not accounted for in the standard New-Keynesian framework.

Keywords: Labor Share, Phillips Curve, Sectoral Data

JEL Classification: E31

Suggested Citation

Lawless, Martina and Whelan, Karl, Understanding the Dynamics of Labor Shares and Inflation (July 2007). ECB Working Paper No. 784, Available at SSRN: https://ssrn.com/abstract=999538

Martina Lawless (Contact Author)

Central Bank and Financial Services Authority of Ireland - Economic Analysis and Research Department ( email )

Dame Street
P.O. Box 559
Dublin 2
Ireland

Karl Whelan

Central Bank and Financial Services Authority of Ireland - Economic Analysis and Research Department ( email )

Dame Street
P.O. Box 559
Dublin 2
Ireland

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